Debt finance remains on tap for buyers of Covid-19-robust businesses

It has become almost a cliché in the reporting of global M&A activity in recent years that buyers, across all sectors and markets, have abundant access to both cash and debt finance.

The ready availability of finance – debt and equity – has been key to powering the transactions market to record-breaking highs.

But with the Covid-19 coronavirus pandemic bringing M&A activity to a near standstill in Q2, what part have the debt markets been playing in this challenging environment?

Three distinct work streams

In reality, the debt markets have continued to function in a remarkably orderly way during these troubled times, with three clear areas of focus:

1. Executing pre-Covid-19 loan agreements

   Even if the business of syndicating loans has, in some cases, been postponed until Q3 to take advantage of improving market conditions.



2. Arranging emergency funding

   Companies have been seeking increased liquidity to see them through the pandemic. The conversion of leverage covenants into liquidity covenants is one method. This activity has been orderly for businesses where recovery looks likely in the coming months, and is irrespective of whether the debt is held mostly by a single fund or through a syndicated arrangement.



3. Raising debt finance for new M&A transactions

   Actively pursued in key sectors, with well-funded private equity (PE) houses at the fore.

    

Where the last work stream is concerned, order books are beginning to look busy with, perhaps surprisingly, a wide range of auction and pre-emptive deals under consideration.

Arguably, this might look like a poor time to sell a business, with pricing under pressure and investor confidence undoubtedly shaken.

However, it may make sense to move now. Particularly if you are selling a business that has survived the crisis, emerged EBITDA-positive, and has a business plan of proven resilience in the most testing of circumstances.

Indeed, PE funds – with record levels of dry powder to deploy – have become noticeably more comfortable with pricing and valuing Covid-19 risk. Therefore, a Covid-19-robust business is likely to attract strong competition from buyers who, with a compelling acquisition case, will be able to secure the necessary financing. 

Sectors in the spotlight

Some sectors are more attractive than others.

PE funds, for example, are actively looking to invest in healthcare businesses, IT and tech companies, especially those offering technologies relating to remote working.

Parts of the real estate market are under severe pressure, notably the commercial property and office markets. By contrast, we are seeing intense activity in warehousing and last-mile logistics, with the sharp increase in online shopping persisting beyond initial lockdowns.

Perhaps unexpectedly, significant deals are taking place in the chemicals sector. This could be the result of an expected increase in the production levels of industries that rely heavily on chemical products, such as automotive. It could also be driven by the fact that this is a largely U.S. dollar denominated industry, making it attractive to funds that transact predominantly in the same currency.

By contrast, the majority of retail and consumer businesses remain in the doldrums, despite some high-value transactions bolstering the sector. PE funds may be under pressure from investment committees to deploy capital, but they are equally under an obligation to invest wisely. Investments in sectors such as hospitality or restaurants are off the table currently.

Redrafting the playbook

The pandemic has transformed the M&A market from a seller’s to a more-friendly buyer’s market, and it will remain that way for the immediate future.

However, with competition for Covid-19-robust assets increasing rapidly, we could see that change in the coming months. If so, the advantage may begin to swing back to sellers, with multiples once again edging towards the levels they reached before the crisis.

For now, we are seeing both sellers and buyers opting for bilateral deals that pre-empt the traditional auction process.

Some PE funds are actively looking at assets they considered buying 12 to 18 months ago, seeking exclusivity for a short period while a renewed bid is put in place.

For some sellers this offers an advantage. They can negotiate a possible sale “behind the curtain”, without going through a public auction process that could fail and damage the value of the business.

Other key trends include:

• growing willingness by lenders to support take-private deals, as stock markets recover; and
• increased use of vendor notes, where the seller agrees to defer part of the payment, potentially to cover a liability, such as a pension fund obligation, in order to seal the deal, and eventually increase value.

Companies that have taken advantage of government loan schemes during the crisis are also looking to do deals that will release them from direct state involvement. Many will want to free themselves from the constraints state support puts on them in order to reward shareholders or offer generous incentive payments to management.

This activity is more advanced in certain jurisdictions than others, for example the UK. By contrast, in Germany (where generous government backing is still readily available) we expect these sorts of deals to increase later in the year and into 2021.

Buy and build opportunities

Covid-19 has had a definite impact on debt markets and their role in M&A transactions. But it has never been a case of being entirely open or shut.

The right deals, involving good assets that have a good chance of recovering strongly (and perhaps more quickly than expected) from the crisis, will attract financing, with syndication also likely to be relatively easy to arrange.

The truth is that investors, particularly PE funds, see this as a moment of opportunity.

Interestingly, PE-backed buyouts accounted for 15% of M&A activity during the first nine months of 2020, the highest percentage of PE deals since the start of 2007.*

In what could be seen as a shift in strategy, many funds are considering assets that offer the chance of consolidation within key sectors, either by merging two big businesses or combining a number of smaller businesses that address similar parts of the market.

These buy and build tactics are likely to be a significant catalyst for transactions in the coming months.

^{* Global Mergers & Acquisitions Review, First Nine Months 2020, Legal Advisors, Refinitiv, October 2020.}