This article is written by Anuj Anand, an advocate, pursuing a Diploma in M&A, Institutional Finance and Investment Laws (PE and VC transactions) from Lawsikho.com.
Merger and Acquisition is an integral part of the Corporate world. Companies want to buy and sell businesses in order to increase their profitability, growth, financial stability or any other reason. However, in the past year the world saw a pandemic that brought in an unprecedented wave of lockdowns, decline and halts of global economies. COVID-19 originating from Wuhan, China brought the world to stand still.
This article discusses the impact of COVID-19 on the business transactions and how it might have ruined some business yet creating opportunities for the others to buy them.
How COVID-19 Impacted the Corporate World
As the news of uncontrollable wide-spread of COVID-19 broadcasted, it made the markets plummet and people withdraw their investments from these public companies. Companies that were typically on the buy-side were now forced to strategize to survive the pandemic’s economic impacts on themselves.
Global mergers and acquisitions have already plummeted as result of the coronavirus crisis, and by the end of March 2020 had reached a near standstill. M&A levels in the United States fell by more than 50% in the first quarter to $253 billion compared to 2019, but most of those transactions were entered into or closed earlier in the quarter before the crisis spread worldwide.
Companies had to redirect the funds, focus and energy of their teams towards companies’ health and skip the long-term goals of acquisitions that were in the process.
Similarly, private equity sponsors have spent an increasing amount of time on efforts to strengthen or save their existing portfolio companies, at the expense of new deal activity.
A few examples of pending deals that were abandoned, such as Xerox recently dropping its $34 billion offer for HP, after having postponed meetings with HP shareholders to focus on coping with the coronavirus pandemic. SoftBank has terminated its $3 billion tender offer for WeWork shares, citing the coronavirus impact together with the failure of a number of closing conditions. Bed Bath & Beyond has initiated litigation in Delaware with respect to delays in the pending sale of one of its divisions to 1-800-Flowers for $250 million. Boeing suppliers Hexcel and Woodward have called off their pending $6.4 billion merger of equals transaction noting the “unprecedented challenges” caused by the pandemic. Investment bankers report that most new sell-side assignments are being put on hold until things stabilize. UK-based Cineworld’s proposed acquisition of its Canada-based competitor Cineplex was announced in December 2019 and approved by shareholders in February 2020. Since then, however, the share prices of both companies collapsed amid concerns that the cinema business might dry up during the crisis.
Why such an impact was caused?
Steep Drop in Valuation
The foremost reason for such a downturn was shrinking in valuation of the companies in the matter of weeks, valuation went down because COVID-19 created a sense of uncertainty of a company’s growth in a particular industry.
In order to demonstrate let us assume TATA group planned to buy COX and Kings Travel booking agency before COVID-19. Now due to the pandemic and lockdown it created halt in all travelling activities. Further, this created uncertainty in the Travel Agency’s earning capabilities. As the earnings were uncertain, it brought down the valuation of the company because the business doesn’t has any income to showcase any return on investment, therefore it is not attractive to the investor anymore as no one know when will the travel sector recover to normal times.
Similarly, there are many such companies in the affected sectors with steep drop in valuation further impacting the M&A transactions in the corporate world.
Material Adverse Change or ‘MAC’ clause
This clause is may be a result that has caused the M&A transactions to be abandoned, it all depends on the wording of the clause. In most M&A transactions, the acquisition agreement has traditionally included a term commonly known as the “material adverse effect” (“MAE”) or “material adverse change” definition. The most important use of this definition is in the closing conditions—the buyer is not obligated to close the acquisition if the seller has suffered an MAE or MAC since the signing of the acquisition agreement (or the date of the seller’s most recent financial statements). The MAC provision seeks to allocate between the parties the risk of certain negative circumstances occurring or existing during the relevant period.
These clauses generally have carve-outs that both the parties agree to, it lay down certain circumstances that would not fall under the definition of material adverse change clause and consequently it could not be enforced by the buyer to abandon the transaction. However, MAC or MAE clauses were not drafted in a way to include “pandemic”, “outbreak” or “epidemic” in the carve-out list.
Therefore, the turmoil created by the pandemic causing the sellers’ companies to be devalued significantly can be a perfect excuse for the buyers to abandon the transaction unless their MAC clauses carve out clauses included “pandemic” or “epidemic” or any other similar medical event in it.
Acquisition agreements and transactions have termination clauses that lays down the time period within which the transaction needs to be completed or the agreement will come to an end and both the parties will not any obligation towards the other. The COVID-19 lockdown and unforeseen delay in the timeline caused many agreements to surpass these deadlines thereby causing the transactions to be abandoned or terminated.
While the large losses scared the investors away from acquisitions, it is actually the time to take the market downturn and convert it into a winning strategy. As many companies that have built good businesses, are undervalued and these companies can prove to be significant investment opportunities. In the next heading certain winning strategies can be found that the companies may use to take benefit of this opportunity.
Potential Winning Strategies
There are several winning strategies for transactions in a weak economy:
- Look Beyond your core Business: Companies need should also go beyond their core business acquisitions and try to benefit from non-core acquisitions that might create greater value as compared to their core-business market.
- Learn from others: There are acquirers/dealmakers that benefit and earn higher returns from such down turns than in regular market. Companies can learn from such dealmakers how to fully leverage such situations.
- Don’t take creation value for granted: When acquiring underperforming assets during weak economic times, even experienced dealmakers create value in only half of their deals. Therefore, the deals have to be thoroughly examined and severe financial scrutiny in due diligence to be sure that the target company would be able to meet its ongoing obligations and satisfy its liabilities.
- Proper Risk Management: If the industry is being hit hard by the current market condition, companies can go for alternative solutions to M&A such as forming strategic alliances could be a way to resolve short-term supply chain issues, or going for acquihire transaction to hire competent and experienced individual and save costs on training entry level employees of a company going into losses.
COVID-19 has weakened global economies, reducing transactions in the corporate world. It is pertinent to understand that companies in several sectors that have built healthy and strong balance sheets over the years are down right now due to the panic sell off and has caused these companies to become undervalued. Such market disruptions creates volatility and great return on investment opportunities.
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