At a glance
- Merger and acquisition activity is expected to rise in the medium term, amid more opportunities to acquire distressed businesses and assets at heavily discounted prices.
- However, the pandemic has changed the nature of how deals are done, particularly when it comes to conducting due diligence and undertaking valuations.
By Gary Anders
COVID-19 has slammed the brakes on global merger and acquisition (M&A) activity.
Yet, despite the dramatic slowdown, deals are still being done, and many experts are predicting a surge in M&A transactions over the medium term, as opportunities arise out of the current crisis for companies to acquire distressed businesses and assets at heavily discounted prices.
Andrew Heng FCPA, group managing partner of Malaysian accounting and business advisory firm Baker Tilly, says the next phases of M&A may occur in four potentially overlapping waves.
“The first wave of M&A will come from deals that are currently under way,” he says. “These are deals that were launched before the end of the first quarter of 2020 and were in process when the economy began to shut down in response to COVID-19.
“The second wave may largely be driven by distressed M&A and non-core divestitures. These deals are expected to be completed in the second half of 2020 and in 2021.”
Heng says the third wave will be led by companies that performed well during the COVID-19 downturn and will be in the market in late 2020 into 2021. The fourth and subsequent waves will bear some semblance of a return to normal business conditions.
“Companies that have returned to sustainable revenue and earnings before interest, taxes, depreciation, amortisation and COVID-19 (EBITDAC) will begin pursuing a sale or liquidity event.”
Due diligence has changed
What is particularly interesting now is the way the pandemic has changed the way deals are being done.
As many governments around the world have moved to lock down their borders and populations, the processes for conducting due diligence on companies and undertaking valuations have needed to evolve.
For one thing, face-to-face M&A business meetings have largely been replaced by online video calls. Operations visits are mostly off the agenda.
Furthermore, deal advisers, including accountants, have needed to review their standard financial metrics for valuing business assets, quantifying current and future sales returns and forecasting earnings.
Some of these adjustments in metrics are likely to be carried over into the post-pandemic world. As many governments around the world have moved to lock down their borders and populations, the processes for conducting due diligence on companies undertaking valuations have needed to evolve.
“The COVID-19 outbreak has undoubtedly created a number of challenges for companies and investors, which will have a direct impact on companies’ cash flows, working capital and earnings,” Heng says.
“Companies and investors will need to focus on short-term cash flow impacts and commercial diligence to understand the impact on supply chains, market share and technologies of changing business models.”
Challenges include management not being able to conduct proper inventory counts, impeding the valuation of unsold inventory and calculations for potential sales returns.
Heng says different industries will be affected in different ways, depending on the nature of their operations.
However, he adds that advisers, accountants and valuers should consider recalibrating their procedures and valuation metrics in a number of areas, to account for the current conditions as well as the aftermath of COVID-19.
Financial metrics considerations
Expanded EBITDA benchmarks: Consider proforma adjustments to reflect 2020 financials under normal operations. It is also important to understand the short and long-term impacts of COVID-19 on revenue, and to fully stress-test financial statements.
Vendors and supply chain: Understand the timing and resulting changes in the company’s supply chain recovery, including its suppliers and key sourced materials.
Direct and indirect overheads: Revisit overheads such as rental expenses, transportation costs, selling and marketing expenses, one-off expenses such as technology upgrades and other costs incurred to enable remote working.
Reductions in discretionary spending: Analyse the impact of reductions in discretionary spending such as advertising, travel and recruitment due to COVID-19.
Employees and contracts: Review all employment contracts, including retrenchment policies and salary adjustments.
Working capital: Historical working capital may not accurately reflect future working capital needs due to disruptions in revenue, payments and business requirements to preserve cash.
Analyse collections and review if provisions for doubtful debts are adequate.
Assess inventory valuations (physical stock counting and inspection may not be feasible), the potential for disputes and provisions for contingencies arising from onerous contracts and short-term disruptions in operations.
Potential impairment: Consider potential impairment losses of intangibles, including goodwill and fixed assets, due to the contraction in economic activity.
Material adverse changes: Many purchase agreement provisions may now include COVID-19 in the wording.
Consider whether this could negatively affect or potentially override earn-out provisions and the calculation of financial metrics.
Post-pandemic tax implications: Assess tax considerations, including any specific incentives granted under economic stimulus packages.
Regulation: Crucially, have a clear understanding of regulatory reforms announced by governments.
Potential shifts to e-commerce: Account for a potential shift to e-commerce platforms, tapping into digital sales revenues.
This will include using innovations in technology, including adopting digital and analytical tools.
“Now, as the economy slowly reopens, businesses enter into a ‘new normal’ that will require carrying over lessons from the height of the crisis while contending with the reality left in its wake,” Heng says.