We are currently experiencing great uncertainties and have been strongly impacted by the COVID-19 pandemic. We cannot yet measure the full dimensions of these events, especially regarding when daily activities will go back to normal. Obviously, the impacts of the crisis and the economic recovery process will be different according to country, sector and company.
During times of economic turmoil, most companies soon realize that cash is the key asset to be preserved. In the current scenario, this has already occurred and consequently many acquisition transactions that were under discussion have been suspended, at least until more clarity regarding the future is available. Many publicly announced transactions were also cancelled since at least one of the parties came to the conclusion that the current scenario does not allow for the necessary transactions conditions to be met. In fact, data for March 2020 already indicates a 40% drop in M&A transaction volume over the previous month – a trend that will likely continue in the coming months.
However, there are situations that thrive even during economic crisis since they involve companies in sectors that have not been strongly affected, or that have even benefited, to some extent, with the crisis. Examples include: healthcare (patient management companies, telemedicine platforms, hospital management intelligence and healthtech segments), food products (particularly shelf stable foods or products that offer some type of convenience), food retail (including online and retail sales platforms with delivery options, supermarket chains and even the so-called “ghost restaurants”), information technology in general and telecommunication services (such as video conferencing platforms, video and audio streaming, among others). In such sectors, overall M&A activity is expected to intensify.
An interesting aspect to highlight is, when looking at past economic cycles, we notice that M&A activities strongly correlates with stock market performance. During periods of economic expansion, companies are usually more capitalized due to easier access to capital for growth acceleration, thus using M&A alternatives as a way to intensify their expansion strategies. During economic downturns, the opposite occurs, and total transaction volume falls.
However, the long-term results of M&A transactions carried out during economic downturns tend to be more consistent than those carried out in economic expansion scenarios. It seems counter intuitive, but there is an explanation for this. During recession periods, the reduction in economic activity assets are usually re-priced and become overall relatively cheaper. Additionally, the reduced number of “buyers” for M&A transactions in less competitive environment results in greater discipline by strategic investors, leading to better long-term results.
Another interesting aspect associated with longer recession periods is that mergers tend to gain more relevance. As many of these transactions do not necessarily involve cash, motivational arguments usually become more defensive. Therefore, two companies that perceive themselves as complementary to each one may merge with the purpose of increasing cost rationalization or becoming more competitive through the consolidation of different links within the same production chain.
Another driver for M&A activity during crisis periods is the fact that many companies end up needing to renegotiate liabilities, either voluntarily or through judicial recoveries. In most of these situations, the solution usually involves the sale of selected assets. We currently have a very sophisticated group of investors in Brazil who specialize in these situations and have extensive knowledge of the Brazilian legal framework to address financial restructuring processes. I believe these investors, along with other more strategic and capitalized ones, will play an important role in M&A activities after COVID-19 pandemic.
Other important agents who are expected to intensify the use of M&A strategies during this scenario are private equity funds. This group includes several well-capitalized investors with deep knowledge of the Brazilian market. In the current scenario, these players will likely benefit from the migration of companies’ funding needs, from “public” capital to “private” equity. Subsequently, companies will benefit from the funding provided by these investors in order to accelerate their growth strategy through selective acquisitions.
Finally, I highlight the role that the Brazilian government will continue to play as a catalyst for M&A transactions, either directly or indirectly. Petrobras, as an example, will continue to sponsor several M&A transactions in the oil and natural gas sector through its divestment program. The market also expects that the national privatization program – one of the pillars of the current government’s economic policy – will be implemented in a more relevant way, as soon as economic conditions improve.