A downturn in economic activity—particularly one as severe as the crisis in 2008 or the current COVID-19 recession of 2020—understandably creates confusion, stress and a tendency to become defensive about business-related matters. This is especially true in Mergers and Acquisitions (M&A), where buyers tend to be cautious with their cash in light of uncertainty, and sellers tend to be less willing to sell at what they perceive to be reduced valuations. Indeed, data reflects these trends. In both the technology crash of 2000 and the financial crisis of 2008, the number of M&A transactions decreased significantly from prior years. On average, valuations were also lower than preceding years. These trends seem to be holding true again in 2020 during the current financial crisis. This being said, there is a case to be made for actively pursuing acquisitions during a downturn. Conversely, the sale of a business can still take place without surrendering potential long-term valuation.
The buyer’s perspective
Companies that find themselves in a relative position of strength during a downturn—those with strong balance sheets and less business disruptions than industry average at the time of a recession—may have a unique opportunity to expand their business and prepare for an accelerated recovery. Transaction multiples that are depressed during a downturn tend to return to pre-crisis levels. In 2005, for example, M&A Valuation to EBITDA multiples were averaging 10.8X but had dropped to 6.5X in 2009, before steadily rising to 11.6X in 2019. In short, companies purchased during a downturn can provide attractive value creation as the economy recovers. In May 2020, the Harvard Business Review showed analysis that total shareholder value of companies making acquisitions from 2008 to 2010 was 6.4 percent, compared with -3.4 percent for companies that did not actively pursue M&A.
This is not very different from publicly traded equities in terms of overall valuation trends. In this case, the difference is that the buyer can look for opportunities to increase the value in ways that cannot be done trading public securities.
Less cash needed for M&A transactions
The amount of cash needed to conduct acquisitions during a downturn tends to be much lower than it would be during normal business cycles. This is primarily due to two factors: lower valuations and increased deal structure. Data shows that during a downturn, deals are completed with more “at risk” consideration—like earn-outs and “rolled” equity—than normal. The current financial crisis brings an additional lowering of the cost of capital to make acquisitions, because interest rates are at historic lows.
Additional benefits post-transaction
Potential for increased returns does not end with lower valuations and financial structuring. In many cases, an acquisition—especially when acquiring a company in the same industry—can present numerous synergies. Cost reductions that come from eliminating duplicate functions can make an immediate impact on the profitability of the combined entity. In some cases, the ability to leverage infrastructure of an acquiring business can be the difference between the acquired company’s operations turning a profit or accumulating losses. Further, access to new customers, channels and talent can also be leveraged against the existing business to create expanded sales opportunities.
Less deal-making opportunities during a downturn
Though there are many perks of M&A during a downturn, one big issue for companies looking to acquire in this environment tends to be the lack of deal availability. For example, deal-making dipped 31 percent in 2008 due to a shortage of quality opportunities. This reduction in companies for sale reflects both the seller’s reluctance to sell at a discount, as well as a buyer’s aversion to acquire struggling companies. These issues may be addressed with a seasoned buy-side advisor.
Working with an advisor
Data shows that buyers can often make acquisitions that accelerate their financial performance though the downturn and during the following recovery. A company’s decision to use an M&A advisor during a downturn can mean the difference between creating significant value or amplifying risk. For a buyer, an advisor can aid in creating an acquisition strategy based on financial capability and growth needs. The advisor can then identify targets for a buyer and perform targeted outreach on behalf of the buyer. Additionally, the M&A advisor can shepherd an acquisition through negotiation, diligence and closing, minimizing disruptions to a buyer’s business.
Be sure to check out Part 2 of this article, in which we discuss mergers and acquisitions in a downturn from the seller’s perspective.