Most people engaged in the business of mergers & acquisitions were flush with deal flow and new business opportunities prior to the COVID-19 shutdown. However, as the pandemic struck, the switch was turned off and M&A activity went dark virtually overnight.
It’s no secret that M&A is cyclical. But, unlike prior economic downturns that have affected M&A, there were no underlying market conditions facilitating this slowdown. The switch was turned off as the result of a global health crisis. So, what happens next? Will the post-pandemic M&A markets revert to pre-pandemic activity levels? Will companies continue to be bought and sold?
In my opinion, the short answer is, yes, companies will continue to be bought and sold and activity will revert to levels near pre-pandemic levels. While certain industries will fare better than others and the pace at which markets return is largely unknown, one thing is clear. For activity to resume, buyers and sellers must adjust their thinking when accounting for the pandemic in their valuations.
Mergers & acquisitions and business valuations have always been a risk versus return analysis. Historically buyers have looked back three years to determine the risks associated with a company’s future anticipated cash flow and their likelihood of achieving those cash flows post-acquisition. In 2020 most companies will show a meaningful decline in their cash flows as a result of the COVID-19 pandemic. This begs the question, should (and will) buyers penalize a company’s valuation for that decline?
Being thoughtful about the reasons for the decline, I submit to you the idea that the decline should be considered an anomaly. A one-time, non-recurring event for purposes of projecting future anticipated cash flows.
Except for certain industries, the decline in demand for a company’s products and services resulting from the pandemic is not a long-term proposition. The company’s business model is not flawed. Demand did not shift due to changes in technology or consumer preferences. 2020 financial results are merely a reflection of a one-time global health crisis that should be treated as such when analyzing future projected cash flows. Historical operating results can still be used as an indication of future anticipated performance. But, only after adjustments for one-time, non-recurring, and extraordinary events such as COVID-19 are made.
Reaching an agreement between a buyer and seller in any transaction is challenging. For deal activity to resume and for M&A markets to restart quickly, buyers and sellers must agree that an adjustment to 2020 cash flows post-pandemic is both prudent but just. Sellers won’t require much convincing as the adjustment is in their favor. But buyers need to adjust their thinking if they want to get deals done, put capital to work, and restart M&A activity.