Creating Silver Linings through M&A During a Downturn
Part 1: Pursuing Unique Growth Opportunities
For most company executives words such as “downturn,” “recession,” “economic slowdown,” and perhaps most fitting for 2020, “global pandemic,” send a cold shiver down the spine. Rightly so, as these periods are associated with stalled growth, pay cuts, layoffs and poor company performance. In the case of dealmakers, financing is difficult, credit markets are not functioning normally, equity markets are depressed and acquirers and targets alike are wary of stock-based transactions. However, what many organizations fail to see is the opportunity to create a silver lining by generating strategic options and disrupting stagnant thinking though the use of M&A. For companies that are well-positioned both strategically and financially, partnerships and acquisitions during downturns present unique opportunities to improve competitive positions and access new growth avenues. As companies ride out the economic turbulence, they should position themselves to emerge from the downturn both strong and flexible—pursuing the right acquisitions can help. In the case of a seller, finding the right majority or minority partner is equally important.
Buyers find value in industry transformation.
Deals made during recessionary periods are often top performers. In an analysis of 24,000+ transactions from 1996 to 2006, a period that included both the Asian currency crises and a global downturn, it was demonstrated that acquisitions completed during or just after the 2001-2002 recession generated almost triple the excess returns of acquisitions made during the preceding boom years. While some of this growth is realized due to “buy for value” opportunities at lower market premiums and reduced interest rates, much of this outperformance is due to transformational M&A.
In a downturn, thoughtful buyers are disciplined in their investment theses and seek targets based on their ability to add value coming out of a slowdown. Buyers know the economics of the business may change because of increased competition, changing input costs, government intervention, new trade policies, new competitors and shifting consumer trends. Successful companies will anticipate these changes to the industry landscape and use M&A to adapt their business models ahead of the competition to protect the existing business and to gain an advantage.
Capital is still available.
Compared to the last recession in 2007-2009, there are deeper and more varied capital sources. It is true that bank lending has declined as a part of overall M&A deal structures; however, the rise of private debt funds, venture capital and private equity (currently holding over $1.5 trillion in dry powder) have greatly expanded the amount and mix of capital. Furthermore, companies are still holding more cash than ever, giving companies with limited paths for organic expansion more liquidity to pursue acquisitions.
Now could still be the right time to sell.
While enterprise value often declines during a recession, a company’s performance during a disruption, value-add capabilities post-downturn and many additional factors must be considered to truly understand a potential buyer’s valuation metrics for such a ‘target.’ Depending on the target’s industry and the emergence of new competing business models post-downturn, the future revenues and cash flows of a target could be just as uncertain as the present. This is particularly true if the target is not actively looking for ways to come out ahead when the economy stabilizes. It is also important to note that an unmotivated owner could unintentionally allow revenue erosion, further reducing the company’s valuation in the coming years. A business owner who is tired and/or no longer willing to spend the time and effort to evolve or reinvent their business is likely to endure declining revenue and valuation—downturn or no downturn. Multi-generational businesses or legacy cohorts considering liquidity should not be too quick to brush off the thought of selling during a downturn. Remaining open-minded to the interest of both strategic and financial buyers can allow sellers to capture much of the legacy value they have created and sidestep the upcoming battles in the next generation of business evolution.