Will consolidation follow the current economic weakness?
The response to the coronavirus has resulted in some bleak numbers – unemployment is way up, GDP is way down and the economic contraction experienced over the last few months has been one of the fastest and steepest on record. Not surprisingly, some merger and acquisition activity has been caught in the downdraft as well.
In January, we had expected 2020 to be a pretty good year for deals for all the reasons cited over the last several years – a growing economy, low interest rates, lots of cash available. This would have been the continuation of a strong decade with three of the past five years among the top five on record for global M&A activity, as reported by The Wall Street Journal. If there was a negative, it was in valuations, with many participants believing the market was too rich.
But we know now the belief that business as usual would continue was mistaken, undermined as the coronavirus emerged and spread. First quarter deal activity contracted severely, down 35% globally and 39% in the U.S., according to Dealogic. Major deals, like Xerox’s $30 billion offer for HP, fell apart or were put on hold. Almost overnight, many of the supportive factors turned negative. Interest rates went down, but banks pulled back on lending and liquidity dried up. Stocks sold off, complicating equity-based deals. Market volatility made getting a handle on valuations difficult. Business activity slowed dramatically.
While the initial shock seems to be receding, the short-term outlook is still uncertain and that uncertainty can result in deals being put on hold. But as markets stabilize and the economy reopens, we believe M&A activity will pick up too. There are two main reasons why we think this may happen. First, many companies will have been weakened by the crisis and will be looking for a lifeline. This will create opportunities for better-positioned buyers who want to add capabilities or technologies, enter new markets, or expand geographically. Second, financial buyers like private equity firms were sitting on huge piles of cash going into the crisis, with many worried about overpaying for assets. They still have that cash and, in some cases, are raising more. Target companies have suddenly become a lot less expensive. That may pull money in from the sidelines.
A recent Forbes article quoted Cornelia Anderson, head of M&A and Capital Raising for Refinitiv, as saying, “It’s likely that the impact of the coronavirus on M&A and capital raising is a story of a delayed effect, where we’ll see activity pushed back to the last two quarters of the year.” (Forbes, 4/3/2020)
That seems probable to us, too. Better stock market performance will help, as will lower volatility and more indications that we have established some kind of bottom. And, of course, it will be useful if further progress is made in the fight against the coronavirus. Whether the ten-year run of record M&A continues remains to be seen, but deals will still be done. That should give merger arbitrage funds like the IQ Merger Arbitrage ETF (MNA) plenty of new opportunities.
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