Development in M&A Transactions during COVID-19
Any attempt to write about recent trends on M&A, without factoring in Corona is symbolic of an ostrich syndrome. Therefore, the impact Corona is likely to have on M&A transactions is considered towards the end of this article.
Meaning of M&A Transactions
Steve Jobs of Apple fame said one should develop the habit of thinking in two ways. One is thinking like lawyers (asking, defining, and interpreting the meaning of every word and expression). The other, a flow-chart thinking (logical). Why? In the context of our topic, the legal method helps understand M&A, while the logical helps to track and benefit from the trends.
M&A stands for Mergers and Acquisitions. Mergers and acquisitions are financial transactions in which the ownership of companies, other business organizations, or their operating units are transferred or consolidated with other entities. This is done as an aspect of strategic management, M&A can allow enterprises to grow or downsize, and thereby change the nature of their business or competitive position. It is a major management decision. Growth can be thought of by increasing marketing area (scaling), by increasing the spread (variety and diversification), or both.
Downsizing is getting rid of non-core-competence areas or shedding the flab. Sometimes downsizing is euphemism for cutting the losses. There is another reason for M&A, it is risk-reduction by diversification in a market of shifting buyer preferences. Other reasons could be to quickly spread wings, to acquire business at a low cost (as in distress M&A), to gain administrative or management expertise or to acquire new technologies through acquisition. Once you understand the concept of M&A you will see a plethora of reasons for businesses going for M&A.
The dictionary meaning of trend is general course or direction followed. A trend is a change or development toward something new or different. With reference to our topic trend encompasses continuing progression in an existing course as well as movement in a new direction.
Trends in M&A transactions
If stock market fluctuations could be thought of as market weather, M&A transactions may be likened to market climate. Normally, the type and volume of M&A transactions that may take place during the coming financial year can be forecast by studying the recent trends of the current year.
Usually, factors that continue to be the same do not contribute to trends. It is those actions that are done or happen to influence and affect market and trade that shape trends. So, let us look at some such events that have happened in the recent past.
Economic slowdown: The much talked about—advancing and denying—economic slowdown in India is a factor that makes a difference to the M&A transactions. Even in a bullish US market there is a feeling of economic downturn. In such an environment, one might expect decisions makers to be more cautious in pursuing M&A transactions. To quote Deloitte M&A Report, based on a survey, the downturn (at least in the US) may actually increase the transactions. Their survey results in the question, “What will Companies do in the event of an economic downturn?” the deal making strategies divided up as follows among Corporate and Private Equity Investor (PEI)* respondents as extracted from Deloitte M&A Report (Trends 2020).
Corporate PEI Regarding/with respect to
48% 37% Maintain competitive positioning
27% 44% Find undervalued assets
15% 9% Seek inorganic growth
5% 6% Divest of non-core assets
5% 5% Seek liquidity assets
(*Private equity is an alternate investment class and consists of capital that is not listed in public exchange. Private equity is composed of funds and investors that directly invest in private companies, or that engage in buyouts of public companies, resulting in delisting of public equity.)
Global trade tensions: Given the global tensions caused by trade disputes between the top two world economies, the opinion is divided as to their impact on M&A transactions. According to a Deloitte survey, More Private Equity Investors (70%) are worried about the negative impact of tariffs on their portfolio companies’ cash flow and operations.
Data protection regulations: India has recently introduced the Personal Data Protection Bill, 2019 (it is presently being analyzed by the Joint Parliamentary Committee in consultation with various groups). European Union introduced General Data Protection Regulation (GDPR) effective May 25, 2018. This is followed by California Consumer Protection Act (CCPA) signed into law on June 28, 2018. According to the Deloitte report, a stable regulatory environment ranks high (third) among all deal makers in terms of achieving a successful transaction—and has moved up in importance in each of the past four years.
To understand how these regulations impact M&A transactions let me quote, Andy Wilson, Partner M&A Services, Deloitte & Touche LLP – “Data privacy can be a diligence issue. A target Company may bring a cyber-security weakness into the organization, or a transaction that involves layoffs or other workforce changes may create data security risks. At the same time, data protection and management can be an integration issue, with a newly combined organization perhaps reaching into new geographies where regulations differ for handling of data.”
SEBI, the Securities and Exchange Board of India was given statutory powers on April 12, 1992 through the SEBI Act, 1992. On August 21, 2019 the SEBI relaxed Foreign Portfolio Investors (FPIs) regulations. The main aim of these proposed changes by SEBI’s August 2019 relaxations is to simplify and rationalize existing regulatory framework for FPIs.
- Now the FPIs would no longer be required to meet the ‘broad-basing’ criterion, under which at least twenty investors were required to establish a fund.
- Now the central banks of the countries that are not members of the Bank of International Settlement (BIS) will be allowed to register as FPIs.
- Offshore funds that are issued by Indian Mutual Funds will be permitted to invest in the domestic market under the FPI route.
These relaxations apart from boosting FPIs are expected to give a push to the M&A transactions.
Is COVID-19 a game-changer?
All the predictions from recent trends gathered—that also took into account economic slowdown and global trade tensions—from the previous year, started going into suspended animation from the middle of February 2020, due to the unprecedented worldwide havoc being played by Corona lockdown.
Let us see how the COVID-19 has so far affected various major industries and jolted the economy.
Here are a few extracts from the article ‘The economics of a pandemic: the case of Covid-19, London Business School (Wheeler Institute for Business and Development).
A major recession is coming:
- Majority of European and US economists predict major recession
- Europeans have a stronger view than US
- Less clear in emerging markets
Impact on stock markets:
Large declines are predicted in the stock markets in 2020. Most stock markets took a nosedive between mid-February through mid-March (plummeting as much as 28% to 38%), after which they have shown marginal recovery. The worst affected is Italy, while the US is relatively better than Europe. Of all China is least affected.
The most affected sectors:
- Tourism and hospitality
- Oil and gas
- Consumer products
- Consumer electronics and semiconductors
Alluding to the analogy of stock market fluctuations to market weather and M&A transactions to market climate, this pandemic’s unprecedented and enormous impact on economy across all major sectors (may be with the exception of pharma and health-care) has wrecked the stock markets (short term investments—the weather) so much that it is a high probability that it would result in M&A transactions (long term investments—the climate) being significantly different from expectations of all the trends collated prior advent of Corona, at least for the year 2020.
Divestitures*: the discussion on trends in M&A transactions is incomplete without talking of divestitures because they remain an important fixture of M&A, driven both by organizations seeking to cash in on high valuations and those aiming to reposition their assets in the face of an economic downturn. So, in the present economic environment divestitures come to fore the moment the crisis starts abating. (*Divestiture is the process of selling off subsidiary business interests or investments)
The latest merger of Nationalized banks in India, to be effective from April 1, 2020 may be dubbed as a kind of divestiture. Here the idea behind merger is not loss reduction of banks but to protect the depositors from inevitable loss because of the accumulated NPAs of some of these banks. By merging them with banks that are doing well, while the resulting balance sheets of the well doing banks do not look as good as they were, the interests of depositors, who are mostly the public are protected. A kind of socialistic approach, like skim the earner to provide to the distressed. The Indian state is more likely to resort to divestiture—for business is never a core function of the State—this time hopefully in time, after their experience to sell Air-India.
Governments run on tax revenue. With the strange situation created by Corona, life has come to a standstill. Economic activity has come to a grinding halt, government revenue has fallen abruptly. While this is so on the revenue side, the need to provide medical support together with macroeconomic adjustments that the governments so far made and are making towards welfare are rapidly draining the treasury. It is therefore reasonable to presume that in days and months to come State may choose divestiture as a way out.
Post Corona period, as economic activity begins to limp back to normalcy, one may see a spurt in distress M&A transactions particularly in small and medium scale industries, either forced by insolvency resolution process* under IBC Act, or prompted by a desire to conserve what is earned, to avert risk of investing more money even to contain the situation.
*It may not be difficult to contemplate the implications of the combination of COVID-19 and IBC on M&A transactions in the light of the India M&A Report 2019 published by Bain & Company in collaboration with Confederation of Indian Industry (CII), in the year 2018 even when things were relatively normal—seventy percent of the M&A activity growth was led by distress deals, enabled through the Corporate Insolvency and resolution processes under IBC.
The question is, is there going to be a paradigm shift in M&A transactions? And if so in which way is the pendulum going to swing? Or is it going to be a totally different trajectory? Well, only time can tell for time is a great healer (as of now of COVID-19) and revealer (of future trends of M&A transactions).
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