The coronavirus pandemic and accompanying market downturn have left mergers and acquisitions in something of a quarantine themselves. Such activity has slowed to a crawl, and uncertainty reigns: What will the landscape look like when this crisis subsides? Where will opportunities arise? Is a recession likely, or has a depression already arrived?
Certainly there are those who have managed to make hay, despite the slump. Witness, for example, the $456 million deal between Johnson & Johnson and the U.S. government, and the accompanying hope that the pharmaceutical giant can fast-track a Covid-19 vaccine. But overall the picture is bleak. MarketWatch cited Dealogic Data indicating that $1.11 trillion in global M&A transactions were completed in the first six months of 2020, which represented a decrease of nearly 50 percent from the same period in 2019. That includes a second quarter in which such deals plummeted by 83 percent in the U.S. alone, from $622.9 billion in 2019 to $106.4 billion this year.
Particularly notable were Xerox backing out of a $35 billion deal to acquire HP, and Apollo Global Management withdrawing its $8.5 billion bid to acquire the broadcasting company Tegna Inc. and aerospace suppliers Woodward and Hexcel mutually agreeing to terminate their $6.4 billion merger. Indeed, a growing list of private equity firms have walked away from deals signed before the pandemic hit. In the private equity space, we have seen financial sponsors dump at least a half-dozen private equity deals so far in 2020 in the United States alone.
In June, the Harvard Business Review polled 50 C-Suite executives about the pandemic’s impact on M&A. Some 51 percent of them said that the crisis had put “a temporary pause” on deals already in progress, and another 14 percent said current deals had been halted altogether. In addition, 26 percent predict “substantially reduced” deal flow for the rest of 2020, and those expecting that “temporary pause” believe it will last until the economic picture becomes clearer—likely later this year.
None of this should come as a surprise, seeing as the U.S. officially entered a recession in June, something many economists foresaw two months earlier. There are also those, like BNP Paribas M&A head Bruno Villard, who believe the pandemic will have a lasting effect on the worldwide economic picture. As he told Bloomberg, “It will not be just a blip in deals flow.” But David Ludwig, Goldman Sachs’ head of Americas Equity Capital Markets, is more optimistic, telling that same outlet that once the threat diminishes, the rally will come “in a reasonable period of time.”
In the aftermath of past global crises, at least those that can be recalled in the memories of current business leaders, the deal economy was eaten by the bears only to run again with the bulls, such as was witnessed after the bursting of the Internet bubble in 2000 and the Great Recession of 2008-09. As in past global crises, not knowing what is going to happen next in the markets has already contributed to buyers renegotiating, delaying, deferring or outright cancelling their M&A deals. What’s different this time is that the impact of the Covid-19 pandemic is primarily on the commercial economy rather than the financial system, leaving a big question mark as to the viability of target businesses (if not the potential buyers themselves).
The risk for buyers to proceed to do a deal in the short term is high, but there are many more factors one has to take into account to get a deal done. In addition to price and other economic terms, there are real new due diligence issues that have to be investigated, if you can even conduct a due diligence investigation in this environment, and one has to assess what debt financing will be available, and on what terms (if at all), and how much additional time to build in to any process for obtaining necessary regulatory and other third-party approvals for deals.
Here’s a breakdown of what’s happening now, and what might happen next:
What is Happening Now
M&A’s impact continues to be felt in the pharmaceutical space. In addition to the aforementioned Johnson & Johnson deal with the U.S. government, the biotech firm Moderna announced in early July that it had entered into a partnership with the Madrid-based pharma firm ROVI.
ROVI will be responsible for finish-fill manufacturing (i.e. vial-filling, packaging, etc.) of Moderna’s coronavirus vaccine, a drug called mRNA-1273, if in fact it is proven to be effective. Just days after this announcement, Moderna revealed that it will begin late-stage testing on the drug on July 27, which involves screening 30,000 people at 87 locations. If all goes according to plan, the company hopes to begin delivering at least 500 million doses a year, beginning in 2021.
The World Health Organization reports that 22 other vaccines are also undergoing human trials, and that 140 are in pre-clinical evaluation. That first group includes the U.S. companies AstraZeneca, Novavax and Pfizer, while Johnson & Johnson and Merck fall into the latter category.
Pfizer, which is partnering with the German firm BioNTech, received a Fast Track designation from the U.S. Food and Drug Administration for two of its drugs, while AstraZeneca, working with Oxford University, was reportedly poised for a July breakthrough of its own.
Meanwhile, two deals were consummated in June that impacted this sector. Merck acquired the Austrian vaccine manufacturer Themis, and Novavax acquired the Czech pharmaceutical firm Praha Vaccines, with the stated goal of producing 1 billion vaccines in 2021. As Pfizer chief business officer John Young told Themiddlemarket.com, “There has never been a more important moment to pursue new collaborations in our industry.”
That was not necessarily true in other sectors. Particularly notable was T-Mobile’s desire to revise the terms of its April 1 merger with Sprint. The Los Angeles Times reported that on June 23, T-Mobile filed a motion with the Public Utilities Commission seeking to extend by two years its original pledge to roll out 5G across California. The company also sought to nullify a provision that it add 1,000 new jobs.
That was indicative of the manner in which the pandemic has impacted deal-making. It had, in fact, been evident as early as March, when Morgan Stanley’s $13 billion acquisition of the discount brokerage E-Trade included specific provisions preventing either party from invoking the outbreak as a reason to renegotiate. Typically such agreements are subject to material adverse effect (MAE) qualifiers, under which either party might be freed from their obligations if an unforeseen event has a long-term impact on a company’s potential. But according to the terms of this deal, the pandemic could not be a reason to trigger an MAE.
Meanwhile, some sellers are pushing back, and hard. After The Carlyle Group and Singaporean sovereign wealth fund GIC abandoned an agreement signed in December 2019 to make a 20% stake in American Express Global Business Travel at a $5 billion enterprise value, Carlyle claimed that AMEX had breached the no “MAE” clause, which did not have a specific carveout in case of a global pandemic. AMEX’s well capitalized investors, including Certares Management and Qatar Investment Authority, did not take this lying down, firing back with a lawsuit in Delaware Chancery Court to force Carlyle to complete the deal and to expedite a trial to require the same.
What Might Happen Next
Media Direct CEO Scott Hirsch, writing for Forbes, believes “innumerable” M&A opportunities will arise from the pandemic. As he put it:
“There are bargains to be had, niche markets to be cornered and economies-of-scale to be achieved. It makes a lot of sense to consider the many M&A opportunities now on the market; the market is ripe for consolidation and roll-ups. M&A in this marketplace are also a great way to rescue failing companies, and the jobs they provide, while enabling customers to continue to obtain these companies’ products and services. It’s a win-win.”
He pointed out that no less a figure than Warren Buffett agrees with him, Buffett having told CNBC that he continues to buy businesses “to own for 20 or 30 years” and that in his estimation, “the 20- and 30-year outlook is not changed by the coronavirus.”
Certainly M&A opportunities have arisen from past financial crises, as companies’ fortunes have waned and they have looked to sell. And certainly there are always plenty of savvy buyers circling overhead, eager to take advantage of diminished valuations. Gap acquired Athleta in 2008 — i.e., during the Great Recession — and Phillips-Van Heusen acquired Tommy Hilfiger immediately afterward, in 2010.
The same thing can be expected to happen now. Hirsch cited statistics from the American Bankruptcy Institute showing that commercial bankruptcies in April increased by 26 percent over April 2019. That list included J. Crew, Frontier Communications and Diamond Offshore Drilling, and the trend has continued since, with J.C. Penney and Hertz among those filing in May, and Chuck E. Cheese and Chesapeake Energy doing so in June.
Meanwhile, private equity firms are lying in wait. Bloomberg estimated that those firms alone have some $2 trillion at their disposal. They might not swoop in immediately, as they have to tidy up their own portfolios, but they will surely be on the case.
Their targets will no doubt be in the travel, lodging and entertainment sectors, which have taken a major hit during the pandemic. The World Travel and Tourism Council is predicting a loss of 75 million jobs and $2.1 trillion in revenue. Also ripe for M&A are industries looking to repair supply chains, once the pandemic is over. Bloomberg pointed to the automotive sector, for example, as one that might be looking to become less dependent on foreign sources for various components.
But again, there are caveats about such things as how a target company’s valuation might be impacted by the pandemic (especially given supply-chain disruption) and how decisions made between signing and closing might affect an agreement, given that they are made during such a tumultuous time.
The due diligence process has also been dramatically altered. On-site visits and in-person meetings have taken a backseat to video conference calls, not to mention the trickiness involved with obtaining original documentation in the current climate. Regulatory matters will also be elongated, which may require extending the “drop-dead” date featured in all agreements (i.e., the date after which either party may walk away from the deal as a result of unforeseen delays).
But there is great uncertainty about all this, as there is with the overall picture, and that uncertainty is as pervasive in the M&A space as any other. The best that can be said is that CEOs who are alert for opportunities, especially in the healthcare and travel sectors, stand to benefit the most.