Private equity transaction activity since the onset of Covid-19 in Europe
Phrases involving the words “unprecedented”, “pandemic” and “R rate” have become all too familiar and, arguably, overused in 2020. They are all relevant and important and reflect the level of disruption and change inflicted on the world during this tumultuous year.
At Liberty we have always believed we should focus on delivering for our clients and, therefore, focus on things we can influence. So, we have spent 2020 (to date) working with great management teams who have been managing their businesses in a wide range of Covid-19 impacted situations and helping them achieve great results.
What have we learned so far in 2020?
It has been a game of three “halves”:
Q1 was a great quarter for transaction activity. Debt funding was plentiful, as was private equity capital and there was a strong flow of transactions with good quality businesses achieving attractive valuations. We advised 9 management teams across a range of sectors including TMT, healthcare, financial services, manufacturing and retail.
Q2 saw the hand brake applied to the M&A market with processes put on hold for an indeterminant time or pulled completely where the target businesses were heavily impacted by lockdown measures. There was limited transaction activity during the quarter but clear evidence that the combination of government support schemes and direct action by management teams alongside their private equity investors meant that the outlook was more promising than some had feared. By the end of Q2 we saw clear signs that many private equity funds were confident enough to invest again and, perversely, the demand driven by availability of private equity capital vs supply of attractive target businesses had become even more weighted on the demand side.
Q2 did see some businesses in sectors shut down by lockdown measures needing to work with supportive investors to manage cash flow issues with some needing to raise additional capital to ensure survival. Many of these situations were managed in a consensual way between management teams, investors and debt providers. This included putting in place changes to management incentive arrangements where we advised our clients quickly and efficiently with a constructive approach taken by all parties. We advised another 6 management teams in the second quarter in a range of different situations – many undisclosed.
Q3 has seen a huge increase in M&A activity levels with high quality businesses being actively targeted by private equity investors keen to deploy capital. The businesses targeted have been almost exclusively in the TMT, healthcare and services sectors where they can demonstrate high levels of recurring revenues, limited to no negative impacts from Covid-19, good historic growth and strong future growth potential. Competitive pre-emptive processes have replaced standard two round auctions and winning bidders have often moved to signing at breakneck speed with equity underwriting for the deal. Transaction value metrics have remained very high, the inevitable consequence of the demand and supply imbalance referenced earlier. We advised 11 management teams in Q3, most in positive, demand led, accelerated transaction processes.
What do we think is in store for the rest of 2020 and beyond?
Our work in progress levels indicate that the market dynamics seen in Q3 have a way to run. Despite the clear and obvious second wave of Covid-19 across Europe, private equity investors remain keen to find the right management teams and businesses to back. In turbulent times with lots of opportunity as well as risk, management teams become even more important and we are seeing that reflected in the incentive plans we are agreeing on behalf of our clients.
It is equally clear that there are significant head winds for many sectors to deal with. Additional debt taken on over the past six months (whether from banks or governments) will need to be repaid, working capital will need to be rebuilt as revenues return once the hoped for vaccine is widely available and permanent holes in balance sheets will become all too clear. This will drive complex restructuring activity and there are bound to be some casualties. Management teams will need help in understanding the implications for them as well as aligning their interests against a new capital structure. We think this activity will be more prevalent in 2021 when businesses have greater clarity on their likely trading prospects.
Looking further ahead, those businesses that have had to manage the effects of the Covid-19 pandemic on revenue generation or operating costs may find it difficult to gain wide acceptance and buy in by investors to underlying profits and cash flow generation going forward. This may make it harder to value businesses and could also drive diverging views on potential returns for investors and hence impact the incentive arrangements they offer. Management teams will need to look out for unachievable hurdle rates and / or more ratchet mechanisms in these circumstances.
In conclusion, we expect the remainder of 2020 to be active in the M&A market with some of this activity spilling over into 2021. What lies beyond that is unclear although, as ever, at Liberty we will focus on helping management teams navigate transaction processes to deliver aligned and motivating management incentive plans.