Global mergers and acquisitions have had a slower start to 2020 compared to other years as companies continue to work through business challenges resulting from the coronavirus.
The November elections may help provide the certainty in the political realm that investors are looking for.
Through June, the total value of announced deals was $327 billion, according to PitchBook. At that pace, the year would end with $654 billion of annual deal value, an 18% drop from the $795 billion of 2019.
A mix of factors has contributed to this period of relative calm, including the severe economic disruption of the coronavirus, and volatile equity and bond markets. But there is another factor in play, one that in the end it could help lift the industry — and, ultimately, the economy: the national elections in November.
It’s often said that investors seek certainty above all when making their decisions, and the uncertainty surrounding not only the presidential election, but the congressional races as well, has contributed to investors staying on the sidelines.
Fast forward to November. No matter which party gains control, investors will gain a measure of certainty surrounding the tax and regulatory environment. And the possibility of a Democrat-controlled White House and Congress may represent an opportunity for private equity firms to make their investments as they rush to beat a potentially more onerous tax environment.
It’s not the only factor at play, of course, but it will become increasingly important as November approaches.
In the end, it could be private equity that helps lift the U.S. economy out of trouble.
Dealmaking in the age of coronavirus
At the onset of COVID-19, optimists argued that declining transaction volume resulted merely from a postponement of deals. But that belief has been dispelled within the most recent monthly data.
Private equity firms were sitting on $740 billion of dry powder as of June.
Although private equity firms were sitting on $740 billion of dry powder as of June, firms have been taking a much more measured long-term approach as certain industries may not yet have seen rock-bottom amid the health pandemic.
To be sure, part of the reason for the decline in M&A activity, particularly for those new to the market, could be attributed to the absence of in-person meetings, which are critical to driving deals from beginning to end. Plus, median buyout equity/EBITDA multiples remain elevated, despite COVID-19, at 8.8x in 2020, compared to 6.6x in 2019.
But for those private equity firms that are disciplined, there will be better long-term buying opportunities as operating companies experience further financial strain – especially around liquidity, which remains the foremost issue for all businesses.
This is where the November election comes in. If Joe Biden emerges as the front-runner in the fourth quarter amid a worsening pandemic, we may see increased M&A activity before year-end as investors prepare for potential tax increases.
There are two important indices we continue to track to project M&A activity:
CEO Confidence Index
The U.S. CEO Confidence Index, a leading indicator of M&A optimism compiled by Chief Executive magazine, was mostly unchanged through its June reading of 6.50, down from 7.00 in February, only a 7% decline. To put that in context, readings for the index below 2.0 were observed during the Great Recession, showing that many chief executives are holding on to hope that the virus will be contained.
If the current reading goes lower, this will imply a reduced willingness to make deals and greater risks for deal execution. We don’t expect this to be the case unless the virus further escalates.
The fear index
The inverse is true for the relationship between market volatility and M&A activity. The Chicago Board Options Exchange Volatility Index (VIX) is a measure of expected price fluctuations in the S&P 500 Index options over the next 30 days. The reading hasn’t surpassed 30.0 in the month of July, having peaked on March 16 with a reading of 82.7.
This reflects a calming of investor sentiment, but with the virus still a threat, we believe this is more indicative of investors adjusting to a new sense of normal – planning for an extended period of significant market uncertainty – rather than of positive economic conditions.
Any sense of bad news — whether political, health or economic-related — could result in a surge to the VIX that may hinder dealmaking.
The takeaway
The future of M&A and the middle market remains hinged on the eradication of COVID-19. The biggest issue that corporate dealmakers will need to figure out is how to create more transaction-friendly terms.
We expect to see a greater number indemnification and opt-out provisions for pandemic relief. With greater market uncertainty comes more contingent deal terms knowing that the markets can change quickly and likewise deal terms.
Economic data points to the worst being behind us, but with the recent resurgence of the virus, that is no sure thing,.
Until market conditions improve significantly, we expect to see a steady rise of proportionate add-on acquisitions compared to platform investments. Doing so, solves two main issues – it offers the lifeline to struggling companies in need of liquidity and spares the private equity firm from buying in at what might be a wrong valuation.
For more information on how the coronavirus is affecting midsize businesses, please visit the RSM Coronavirus Resource Center.
