When COVID-19 spread around the globe in the early months of 2020, it caught the world by surprise and many businesses were unprepared. Governments and organisations responded in various ways, with different impacts on the business world generally, and merger and acquisition (M&A) activity in particular, although there have been some similarities as well.
Uncertainties remain but while lack of preparation was an issue at the beginning of 2020, it no longer needs to be an obstacle as businesses can identify the opportunities available to them now so as to better position themselves for success in 2021 and beyond.
Initial impact and response by region
During the first three or four months after the COVID-19 pandemic spread throughout Europe, Middle East and Africa (EMEA), the level of uncertainty in the market, combined with low business optimism and confidence, was so high in the region that there was little M&A activity. However, generous government support programmes, including support for employees and payroll, as well as creditor forbearance schemes, have allowed many companies to weather the storm through 2020.
The generosity of government support and subsidies during these times led to the number of distressed M&A opportunities being lower than expected in the region, while deal activity has largely focused on defensive strategies such as asset sales rather than lender-forced transactions. There have been many announced or planned initial public offerings (IPOs), which is evidence that there is money in the market with investors actively looking for opportunities, in particular private equity firms. Parties to transactions have been relying on representations and warranties insurance to a greater extent due to the level of uncertainty in the market. The same pressure has contributed to deals closing at a slower pace, with a more intensive due diligence process.
Once government support is reduced or disappears, a likely increase in distressed market activity will be seen, as some businesses continue to struggle and as a second wave of the virus makes its way through the region. Recovery for these businesses will depend on how long the economic consequences of COVID-19 lasts. The number of necessary restructuring transactions and insolvencies will likely increase as a return to some form of pre-COVID normalcy takes longer to materialise. A significant uptick in semi-distressed M&A activity and, in particular, transactions fuelled by large amounts of unspent private equity ‘dry powder’ looking for bargains, along with industry consolidations and Asian investment into Europe, are expected to start in 2021.
In the Americas, and the US in particular, many companies were in survival mode in the second and early third quarters of 2020. Distressed transactions were fairly prevalent, including debt restructurings, defensive M&A transactions such as liquidity planning, and other transactions to strengthen balance sheets. This was due in large part to uncertainty about the evolution of the pandemic and uncertainty about the level of government support.
As the summer evolved, deal market activity accelerated and the presence of impatient private equity money became noticeable. This is due in part to cheap financing continuing to be readily available and the banking and lending systems remaining quite stable. Another dynamic particular to the US has been the presidential election and the prospect of an increase in tax rates and a roll-back of many of the 2017 tax reform measures sometime in 2021 or later. This has led to an increase in the sale of closely held businesses, corporate divestitures, and public company deals, as well as consolidation in various sectors to reduce costs and drive synergies, gain market share, acquire new customers and/or geographies, and otherwise strengthen one’s market position.
In the Deloitte survey published in October 2020 – M&A Trends Survey: The future of M&A – US dealmakers described their M&A strategy in response to the current climate as: Responding to structural sector disruption by accelerating long-term transformation to other business models (33%), using M&A and other investment activities to capture unassailable sector and market leadership (24%), maintaining parity with the competition (23%), and preventing further deterioration of current weakened market position (20%).
Companies have also been looking to streamline transaction teams in part by engaging fewer professional service providers to handle more aspects of a transaction, including finance, tax, and cross-border legal due diligence, as well as assistance during the implementation process. In this environment, where much uncertainty remains, buyers and sellers have been bridging valuation gaps through the use of earn-outs in negotiations and managing other issues through the use of representations and warranties insurance.
The combination of full private equity coffers, stable financial systems, and the threat of tax increases in the US has been driving the M&A market and continues to do so. Since the third quarter of the year, most elements of the deal market have been very active and there has been a spike in deal volumes. IPOs, including acquisitions using special purpose acquisition companies (SPACs) are becoming increasingly common, as are non-traditional transactions such as alliances and ecosystem partnerships, joint ventures, etc.
Lastly, robust technology, dynamic financial services, and distressed energy sectors have fueled extensive corporate transaction activity. Meanwhile, the list of companies that will struggle or thrive through these difficult circumstances is getting clearer, allowing more accurate company and asset valuations and preparation for future transactions.
The picture in the Asia-Pacific region has been more mixed as COVID-19 has affected countries differently.
China, which recovered from the pandemic earlier than other countries, has seen an acceleration in M&A activity. Some government and creditor support in other countries, such as a moratorium on interest payments and a temporary ban on new insolvency filings in India, has helped suppress the number of distressed transactions. However, governments and lenders are becoming increasingly uncomfortable as lengthy support measures could threaten their own recovery. Where government or lender support has been lacking or less generous, bankruptcies and restructurings have been more prevalent.
Once support measures are phased out, distressed activity is expected to increase. M&A activity has been increasing steadily in the second half of 2020, such as in China, India, Japan, and Singapore, although each country is on a slightly different trajectory and deal activity is still below expectations in many countries.
One common feature of the deal market has been a significant increase in inbound investments from private equity from all over the world, which is a reversal of the types of deals that were prevalent before COVID-19, i.e. outbound investments by Chinese investors. While some inbound deals have been strategic, the majority of transactions have involved distressed acquisitions and divestitures. Similar to the EMEA and Americas regions, more and more companies in the Asia-Pacific region have been looking for efficiency, scale, and cost reductions either by consolidating professional service providers or by bringing more transactional work in-house.
Key considerations for the new deal landscape
While uncertainties about the global economy remain and second waves of the virus affect many countries, companies should prepare to strengthen their positions for survival and success in the new normal when the COVID-19 pandemic is over. Their focus should be on certain fundamental concepts affecting how they handle future transactions, as well as developments in the economy more broadly.
M&A planning and due diligence
Opportunities in 2021 will abound for companies that are in the right place to capitalise on them, whether these open up new markets for them or allow them to make bargain acquisitions. Planning and due diligence will be key for those who maintained a strong position through the pandemic, thinking through the different scenarios and alternatives in front of them, and determining which type of strategy they need to implement, be it offensive or defensive with corresponding tax risks, opportunities and future business state tax modelling.
For M&A planning and due diligence to be successful, companies should be very clear and certain about their acquisition goals ahead of time. It is more important than ever to stop and ask the question – how does this company or asset acquisition fit into my business strategy?
For this reason, acquisition strategies should be communicated to professional advisors, including for tax, early in the planning stages, allowing them to provide the most relevant and comprehensive planning and implementation advice possible and anticipate potential hurdles and risks, allowing their clients to adjust their plans, as necessary, before great costs are incurred.
Tax can also be a significant source of synergy in a transaction and have a meaningful and favourable impact on enterprise value. As such, an integrated strategic tax review powered by new technology should be part of any pre-deal discussion and ultimate structuring and integration work, with a focus on identifying risks and opportunities, listing priorities, setting timelines, and laying out how execution will bring synergies to light in the near and long term (e.g. through value chain alignment, efficient financing, utilisation of tax attributes, legal entity integration and simplification, refund and incentive opportunities domestically and across the globe, etc.). Technology acquisitions through industry convergence will also be important as companies that use M&A to digitise their own businesses could strengthen and bolster their supply chains and product enhancements as well as access new markets, new customer bases, and new data.
Consolidating professional service providers should play a role too, reducing costs, risks, and inefficiencies, and speeding up execution. By leveraging and consolidating the parties that perform legal, financial, commercial, and tax due diligence, companies can drive automation, efficiency, and cost control into the process in a very thoughtful manner.
Understanding the target: Business, tax and legal perspective
Having a good understanding of the commercial aspects of a business target is important as well, especially as the commercial landscape has changed as a result of COVID-19, upending traditional assumptions and business models and increasing uncertainties.
In the UK, for example, the traditional business model for leases has been ‘fixed rental businesses’ meaning rents consist of a fixed amount that increases periodically. As a result of COVID-19, recent company voluntary arrangements (CVAs) have completely torn that business model apart, converting fixed-retail price index (RPI) leases into turnover-based leases which calculate rent as a percentage of turnover and are not fixed. If a company is looking to acquire a business that has some exposure to retail, has it thought about what would happen if the leases that it thinks it is buying are suddenly linked to turnover? What assumptions have been made and how uncertain might those be? As a tax professional, are you asking the right questions to be informed in the ‘new normal’ of the business and the potential impact on your tax profile?
Added to a greater understanding of the new commercial landscape should be a greater than usual dose of skepticism when looking at a potential deal because there is a lot of market distress. Acquirers should ask themselves why a seller is selling at this time and should also think about risks that they may not usually be concerned about, as well as what the strategic, tax, and legal implications might be. Not least whether any warranties and indemnities being given by a vendor have any real value.
Considering the wider economy and the future of work
There are also broader shifts in the deal market and the economy that have been accelerated by COVID-19, and that should be considered when looking to do a transaction.
Companies should think through how the future of work will impact their business and a transaction’s synergies. The movement of people and functions away from traditional places will have a different impact on different organisations and could increase some risks, while resulting in cost savings over the next five to 10 years – though it may increase the compliance obligations in terms of employment contracts and income tax, among others.
A corollary to this is the future of the city. Space in some cities used to be dedicated to one particular purpose. As this changes, governments will need to think about how to regenerate affected cities, a shift that will impact businesses that operate there.
These shifts underscore how resilient companies need to be in every aspect of their business, not only from a financial perspective, but also from the perspective of talent (attracting and retaining it), operations, supply chain, tax, and data, to name just a few areas.
A key component of a business’ arsenal in becoming and staying resilient is investment in innovation. Governments are going to have to invest greatly in new technology and infrastructure to create economic stimulus. However, these investments are often linked to a strategic shift towards sustainability. One example is Europe’s investment in the electric vehicle infrastructure, and green energy and sustainability more broadly. Therefore, any business that is involved in this type of capital spend or its design, or that is a recipient of it, stands to benefit. Major innovations could have a large impact on many businesses in many different sectors. Businesses that do not want to be left behind need to think about how they can innovate their own products, services, operations, and supply chains. M&A has an important role to play in this as well because companies can either innovate themselves or acquire innovative targets.
While uncertainty remains, the promise of effective vaccines in the pipeline may well bring some confidence to move forward with the opportunities available. 2021 may be the year rewarding the resilience from 2020.
Brian Pinto is a partner in the international tax and transfer pricing (TP) services practice in Deloitte in the US, and serves as the global tax and legal leader for mergers and acquisitions (M&A). He also has more than 23 years of experience advising US multinationals on cross-border financing arrangements, foreign tax credit utilisation, local tax minimisation and offshore treasury optimisation.
David Hoffman is the US M&A services tax leader, specialising in delivering tax consultative services relating to M&A and other significant capital transactions, such as restructurings, dispositions, and debt work-outs.
Mark Ross is a principal in the legal business services practice, which uses Deloitte’s global multi-disciplinary approach to provide innovative solutions to legal departments in the US. From across a single global platform, Deloitte is bringing to bear for the legal department, the transformative approach that has shaped other business functions and industries.
Marcus Rea heads the European restructuring services tax network. He specialises in providing tax advice for financial restructurings and other similarly complicated transactions. He has more than 20 years of experience in lending reviews, refinancing, distressed M&A, insolvency and corporate simplification assignments across all industries and geographies.
Siobhan Godley leads the real estate practice across the UK. As a chartered accountant and chartered tax adviser with more than 20 years of experience, she advises on real estate transactions and specialises in complex inbound and joint venture transactions with strong credentials in advising institutions across the US, Europe, Asia and the Middle East.
Markus Schackmann is head of the global service line of M&A for Deloitte Legal. He advises exclusively in the area of national and international M&A and joint ventures, in particular on the complete transaction process starting with the structuring of the transaction to the contract negotiations and the support of the financing.
Amrish Shah is a partner with extensive experience of working in M&A. He specialises in international tax, income tax, tax and regulatory advisory work for M&A, corporate restructuring (mergers/demergers/slump sales), and succession planning.
Xiangyang Ge is an international partner with Shanghai Qin Li (Beijing) Law Firm. He assists Chinese and foreign clients in cross-border M&A, restructuring, joint ventures, and other types of investments. He regularly assists large Chinese enterprises and institutions in their outbound investments.
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