The COVID-19 crisis is already showing signs of pushing the UK economy into recession, has undoubtedly impacted the M&A market in the UK and increased the likelihood of businesses entering into insolvency proceedings. However, history tells us that shocks to the market do give rise to opportunities it's a question of knowing where they are and being prepared.

In this latest Insight, UK Corporate M&A Partner, Ragi Singh, gives our view on:

  • Where is the UK M&A market now?
  • Where (and for whom) are the UK M&A opportunities over the next 12 months most likely to be
  • What could potential buyers and sellers usefully be doing now to capitalise on those opportunities when the UK M&A market returns?

Where is the UK M&A market now?

Unsurprisingly clients', corporate finance advisers' and our own experiences tell us that the domestic and international M&A market has suffered a shock and is suffering its own "lockdown". With rare exceptions (see below), new processes are being put on hold and existing processes (unless very well advanced and in sectors less affected by COVID-19) are being mothballed as buyers and sellers re-evaluate their strategy, targets and how they will finance (let alone run) transactions.

When we will return to some sort of normality is the multi trillion dollar question (given the US$4.1 trillion (5% of global GDP) effect COVID-19 could have on the global economy according to the Asian Development Bank)? Sentiment ranges between the extremes of: "no normality until we have a vaccine as without that there is no certainty that we will not suffer a second pandemic wave (possibly as soon as Q3/Q4) so investment uncertainty reigns", through to "there will be a rush of new processes kicking off in September as macroeconomics will dictate that the world will need to return to some level of normality and there will be pent up demand to satisfy." In short, we are in for a quieter summer than usual at best.

Where (and for whom) are the UK M&A opportunities over the next 12 months most likely to be?

It is all too easy to be sucked in by the doom and gloom and paralysed by it. In contrast we and a number of our clients are, in parallel with keeping their businesses ticking over, already considering how they can emerge stronger post COVID-19 and identify where the opportunities for inorganic growth lie. The working presumption being that for those not fortunate enough to be in the unaffected or boom sectors, material inorganic growth in the short to medium term is unrealistic.

Lack of Acquisition Finance

It's no secret that the banks are restricting the flow of acquisition finance as they focus on supporting their existing portfolio clients' day to day business needs. This is playing into the hands of buyers with stronger balance sheets and a cash war chest. Given that other economies are (and will) recover quicker than our own (e.g. China) we think cash rich overseas buyers will come to the fore as a result.

Brexit and Weakening Pound

Valuations could also become suppressed as COVID-19 delays Brexit deal negotiations and postpones the clarity the market craves. Brexit uncertainty increases risk but that may be priced into deal values. Couple this with a weakened Pound and UK valuations begins to look attractive to overseas buyers.

Fewer Domestic Buyers

Leveraged buyers and PE houses may pause as they struggle to raise finance. Even those houses with plenty of capital to deploy are finding it problematic to obtain investment approval - presenting a reliable profitability / run rate picture for most businesses is currently extremely difficult. Whilst this will not be the case for all houses, history shows that a few of our PE clients have done very well out of maintaining investment levels during economic downturns, the upshot is that for the short term there may be fewer domestic buyers to compete with. Combined with the above, this creates a perfect storm for overseas cash rich buyers.

Where Are the Targets?

These fall into some clearly defined categories:

  • Non - Core Divestment: a number of these were in the pipeline / underway before COVID-19 hit. The reasons behind the divestment decision will no doubt be exacerbated now and we think these processes will be expedited when some semblance of normality returns.
  • The less challenged sectors: clearly, there will be some sectors less affected by COVID-19 coming out of this period, including the following:
    • Tech;
    • Energy;
    • Food;
    • Online retail;
    • Logistics;
    • Public sector; and
    • Healthcare.
  • The more challenged sectors: others will be deeply affected and present buying opportunities as they fall into distress. The government's and lenders' supportive measures will not last forever and the banks will (whilst initially being reticent to start insolvency proceedings) put sellers under pressure to sell if they believe a willing buyer is in the market. Some of the sectors falling into this category are:
    • Real Estate and Construction;
    • Hospitality and Leisure;
    • Retail;
    • Automotive;
    • Aviation;
    • Travel; and
    • Natural Resources.
  • Regulatory change leading to a sector becoming more attractive or ripe for consolidation:
    • Renewable Energy: a sector often subject to regulatory change and positive developments are emerging. BEIS has launched a consultation proposing that new onshore wind and solar will be able to apply for Contracts for Difference (CfDs) when the next auctions are held in 2021. This step will further encourage an already buoyant development market (UK renewables planning application are at an all-time high) as a CfD sets a floor on returns and greatly enables finance for those projects winning a CfD.
    • FCA/PRA: firms subject to these regimes have minimum capital requirements (one reason why the major clearing banks are freezing dividends). This will become challenging for less well capitalised firms as the year progresses and so may present opportunities for consolidation / acquiring firms at a discount.
  • Private Investments in Publicly Traded Equities (PIPE): these are a private placement of restricted equity securities of a public company that is made to selected investors. The issue will normally be to private equity, venture or growth funds with cash to deploy and will normally be done at a discount to the market value. PIPE transactions tend to occur when equity valuations have fallen, cash flow is an issue and a company is looking for a new source of capital when there is limited availability of equity financing, and companies may be finding it difficult to finance through traditional methods. Generally the transactions can be completed relatively quickly (depending on due diligence periods), give the company access to capital quickly and there is generally less legal documentation required (particularly for AIM companies who are not required to produce a prospectus for a PIPE).
  • Loan to Own Transactions: as the number of leveraged/distressed businesses coming to the market increases we are likely to see more loan to own transactions occurring as a means of acquiring such businesses outside of formal insolvency arrangements. These transactions can a take a variety of forms but generally involve a buyer either: (a) acquiring a secured debt position (for a price far lower than the outstanding debt amount) and then enforcing that security to take ownership of the business or (b) injecting new debt into a business coupled with the issue of shares giving it a controlling equity stake.

What could potential buyers and sellers usefully be doing now to capitalise on those opportunities when the UK M&A market returns?

We cannot collectively standstill. It's no easy task but, whilst keeping our businesses alive, we need to look at life beyond COVID-19 and be ready to make up for lost time. We need to make sure we are in the best possible shape when normality returns and proactively "make the market". Things to be doing include:

Sellers:

  • use COVID-19 to come out of the other side with a more efficient business / business model – speak to advisers on
  • how you can reshape your business to make it more attractive;
  • find the value eroding skeletons and use the M&A hiatus to deal with them;
  • be ready for activist shareholders to clamour for the carve outs put on hold to be executed as a priority; and
  • consider PIPE transactions to raise funds.

Buyers:

  • use COVID-19 to come out of the other side with a more efficient business / business model - speak to advisers on how you can reshape your business to make it more attractive;
  • find the value eroding skeletons and use the M&A hiatus to deal with them;
  • be ready for activist shareholders to clamour for the carve outs put on hold to be executed as a priority; and
  • consider PIPE transactions to raise funds.
  • look at and strengthen relationships with alternative funders e.g. debt funds and consider strengthening your balance sheets with targeted fundraising;
  • engage with advisers (including insolvency practitioners) so they are aware of your appetite for investment and can help shape your strategy;
  • follow the press and the UK courts register of winding up petitions for evidence that a chosen target is in distress and have your legal and financial support lined up so you can move quickly (see our alert on how to best position and prepare yourself to be the successful bidder in and insolvent sale processes;
  • use the present standstill to begin conversations with / get to know targets better and "incubate" them so that you have a head start over other potential suitors when they come to market;
  • get your foot in the door with targets - consider minority investments now with a view to future majority acquisition or loan to own transactions; and
  • consider PIPE investments in companies where hitherto you have avoided doing so e.g. due to rising markets or lack of control.

Next Steps

If you have any questions relating to the UK M&A market, your M&A strategy, preparing your business for sale or embarking on an acquisition programme (be that for solvent of insolvent targets) please contact Ragi Singh.