Transactions Outlook 2020: Mid-Year Review


As the pandemic continues on, reconfiguring the future of the global economy, a great divide between industries that are faring well and those that are struggling is emerging. We witness how technologies that help us translate from physical to digital world excel in these difficult times. But what will be technologies that will shape the next chapter of the future and the way we conduct business for the time to come? And what are the emerging trends that will transform the business going forward?

Our emerging technology specialists Patrizio Prospero, HLB Malta and Alex Duffy, HLB UK recently discussed these questions with Chris Maresca, Managing Partner at C32 and Katie Palencsar who serves as an Investor and Venture Studio Lead at Anthemis Group during the 2020 HLB Audit-Tax-Advisory Conference. In this article, we are sharing the valuable insights collected during this panel discussion, to help make sense of the future and prepare for the new competitive landscape that brings new threats and opportunities that are shaping up to define the economy for the foreseeable future.

Business models that thrive in today’s challenging times

Economic shocks often accelerate the creation of new business models developed as a response to a new environment. For example, the surge in new, nimble companies offering digital financial products was a result of the financial crisis in 2008. Katie Palencsar, involved primarily in investing in early-stage FinTech companies this time sees three areas emerging as relevant and thriving in the post-pandemic environment: risk management, e-commerce and fraud prevention especially as 81% of companies experience payment fraud. Also, as the labour market has been flooded with job seekers, this may have a twofold impact for start-ups: first, there’s a big opportunity for early-stage companies to recruit good talent; and second, as the pandemic has demonstrated that job security is a fragile concept, more people may try their chances with starting their own business.

Another impact of the pandemic is the widespread rise of remote work and digital business models that Silicon Valley pioneered decades ago. While remote working has been around for quite some time in some sectors, others have been sceptical about them. But with the virus outbreak bringing economic activity to a screeching halt, the world was forced to adopt remote working with sudden accelerated wholesale digitisation of businesses. As remote work is gaining credibility, we will see more people leaving expensive cities as employers realise that coming into the office is no longer required to get the job done, said Chris Maresca.

We expect that, as people limit their social exposure in an attempt to curb the spread of the virus, businesses that don’t rely on physical presence and human contact will excel as well as those that managed to position themselves as a solution for the gap which has opened up due to quarantine restrictions. Alex Duffy sees these solutions as products such as chatbots, video content management software, live fitness and virtual conferencing.

Where are companies looking for growth and market share increase?

The question is, how can companies pivot to meet the requirements of the new reality? Alex Duffy illustrated the need for businesses to swiftly adapt with the British shirt maker TM Lewin. A more than 120 years old business has decided to close all 66 UK shops and take all its sales online. Those companies that manage to reinvent their businesses to fit digital and online presence will be well-positioned to survive and thrive in times of restricted social interaction.

Admittedly, pivoting and radical changes will bring new challenges in their own right, as they lead to a completely different growth model. For example, with the easing of restrictions in the UK, pubs will impose a serving minimum, which will decrease the number of customers at the venue but will increase revenue per person – changing their growth model and how they conduct business for the foreseeable future.

With restrictions commanding social distancing and consumers changing their buying habits, businesses that are related to home delivery are rapidly growing. Chris Maresca reports that areas such as third-party logistics, including delivery and logistics backend, have seen explosive growth as many US small businesses which were let down by Amazon over the course of the pandemic are now looking for alternative third-party solutions. Similarly, with wholesale agricultural revenues dwindling during the lockdown, agriculture is seeking to find direct-to-consumers solutions. Direct-to-consumers solutions are reporting growth in other areas as well, but an important consideration is that these models are heavily relying on customer service and human touch.

“We are just at the beginning of some sort of revolution. I am not sure what that means in terms of new services that are going to emerge out of this, but this is the place where we start building completely new dynamics and new business models”, Chris Maresca, Managing Partner at C32.

The changing customer behaviour and how it impacts customer experience

As an investor involved in collaborating with early-stage FinTech start-ups, Katie Palencsar reports that consumers are currently craving information about the topics that are are all of a sudden more relevant to them as a result of the economic impact of COVID-19. As a result of this a growing number of consumers are becoming more interested in topics such as insurance, financial planning, retirement and end of life planning. Instead of just sending e-mail newsletters for example, companies are responding by creating and delivering content that is within the actual software platform their customers are using.

The current state of start-up funding

Discussing the possibilities of start-up funding in the current environment, Chris Maresca highlighted it is important to distinguish three types of start-ups as not all of them will have the same fate in the post-pandemic economy: 1) Those that have a solid business model and that managed to raise funds for 1-2 year runway before the pandemic hit; they will do well going forward, but might face challenges to raise funds in their next round in one or two years; 2) Companies without a robust business model which pandemic caught in the middle of fundraising; they will struggle to recover from the pandemic shock; 3) Start-ups with solid business models that were either in the middle of fundraising or will shortly have to fundraise; they will survive. There was far too much capital available far too easily in Silicon Valley for the last five to six years, funding a lot of speculative business models. What the pandemic changed is that investors now require companies to generate revenues right away, which is a good discipline. Although there is still a lot of capital in Silicon Valley, the revenue-generating capacity of new companies now takes priority.

Continuing along the similar lines, Katie Palencsar added that she has been witnessing record-breaking pre-seed rounds that go as high as US$1.5 - US$2 million, an amount that would be hard to imagine only a year ago. Another trend on the rise is that corporates are increasingly working together with VC investors, setting up accelerators, venture partnerships and developing  initiatives in an attempt to address what is happening in the world but also understanding innovation is a long game, positioning themselves for the future growth of their business.

KPIs investors looking at during uncertain times

Despite heightened uncertainty, ventures are set up in a way that requires active deployment of capital as the funds are committed and there is a life cycle of those funds. What are the KPIs investors are relying upon in these volatile times?

Katie Palencsar works with FinTech start-ups at their pre-seed and seed stages. Her experience mimics that of Chris Maresca’s when it comes to the ability of companies to generate revenues. “What pre-seed and seed investors love to see is some sort of customer validation. Even with some concept companies, we have even seen founders present some signals of customer buy-in, whether that’s a hacked together beta with users or even validated survey data. “, shared Katie Palencsar, Investor and Venture Studio Lead at Anthemis Group. In addition, team is beyond critical when investing in early stage companies.

What is technology that will shape the future?

The world economy is at the inflection point, as almost every aspect of the way we conduct business is changing. The Tech sector is a clear winner during this evolving time, but what game-changing technology is going to be the one that will shape the future that is ahead of us?

For Alex Duffy, that’s blockchain and tokenisation. ‘’One technology that hasn’t yet found its place, but is increasingly doing so in this pandemic is blockchain and tokenisation. Blockchain will be the way forward to keep track of all the things in non-physical reality “, Alex Duffy, HLB UK. With increasing digitisation, cyber risk and fraud, blockchain is going to become more relevant and can position itself as a revolutionary solution for tracking digital transactions, monitoring assets, signing documents. For keeping track of things in the non-physical world, blockchain will be crucial going forward.

For Chris Maresca, that’s low-latency, high-bandwidth internet service with satellite communication. Although remote work gained credibility during the pandemic, we are entering a phase of distributed everything, not only work. For this, we will need a reliable, consistent internet connection. Distributed high-speed networks and distributed computing are going to change the dynamics.

The Pandemic Impact

As 1H20 was nearing an end, the full impact of COVID-19 across the world economy started to emerge. The disruptive effect of the shock unparalleled both in terms of size and order was reflected in the M&A deal activity, particularly during the second quarter of 2020. According to the Global & Regional M&A Report 1H20 which was recently published by Mergermarket, deal volume fell by 32% from 1H20 to 1H19, (6,938 vs. 10,155 transactions), while deal values plummeted by staggering 52.7% (USD 901.6bn compared to USD 1.9tn) — an environment reminiscent of the aftermath of the financial crisis of 2008.

The difference when contrasting quarters is even starker - deal volume has fallen steeply from 4,308 deals in 1Q20 to 2,630 in 2Q20, with deal values dipping to USD 308.9bn from USD 592.6bn in the preceding quarter.

However, the impact of the virus outbreak propagated unevenly throughout the global economy and hence materialised differently across various regions of the world. Although the first affected by the virus, China experienced the least impact on its global buying activity with deal count declining by just 7% and deal values by 20.1% on a year-over-year basis, offering a glimpse of hope for other countries that the deal environment will head towards gradual recovery as the epidemiological situation improves – still reminding us that resurgences of COVID-19 will continue to constrain the upside. In contrast, the Americas, dominated by the US market, saw the most significant decline. Hindered not only by the pandemic but also political uncertainty stemming from the imminent presidential election and rising social unrest, US share of global M&A by value declined to 33.4% in 2020 compared to 52.8% in 2019, leading to an expansion of other regions, most notably Europe, (with a 32.3% market share) which slightly squeezed out Asia (27.7%) in achieving the largest market share gains.  The European M&A activity declined by 30.6% - from USD 419.9bn in 1H19 to USD 291.5bn in 1H20, while the total value of US M&A activity declined to USD 274.5bn, which is the lowest half-year activity since 2003. ORBITT conducted a study covering the M&A market in Africa using data tracked on its platform to compare levels of deal activity between 2019 and 2020, documenting a 71% decrease in equity investors engaging in new investment leads (76 in H2 2019 vs. 47 in H1 2020).

Current Market Themes

Drawing a sharp demarcation line between the industries, the pandemic clearly set apart those that are struggling as highly impacted by the dramatic change in consumer behaviour and the consequences of global lockdown and those that are proving COVID-19 resistant. The former include healthcare, technology, essential retail and construction, while the latter cohort includes non-essential retail/consumer, manufacturing, restaurant/services and transportation.

Although the Global Financial Crisis remains the closest historical reference, the pandemic has generated its own unique challenges and opportunities. Unlike the financial crisis, which resulted in the collapse of the debt market, the debt market and the availability of capital today are robust. There had been more tightening, particularly on the senior debt market in terms of leverage and pricing risk, but also an expectation that M&A transactions will pick up in 2021, with a possible exception of private equity activity which may see a bit slower recovery.

We are already observing that the terms of deals are changing, with a more noticeable presence of earnouts. Valuations are starting to incorporate the effects of the pandemic, with new metrics such as EBITDA_C reflecting the COVID-19 impact as buyers are beginning to price this risk factor to ensure that they have a full understanding of the target’s operations.

On a positive factors side, customer confidence remains positive in the wake of opening up of the economy. As strategic acquisitions are still active, today’s environment represents a ripe market for strategic acquisitions, while corporate divestitures have seen the rise. Further, tech and tech-enabled businesses are performing relatively well and the low-interest-rate environment allows favourable terms of debt financing while the corporate sector and private equity investors maintain healthy volumes of cash and investable capital.

On a negative side, the world economy is confronted with a risk of multiple waves of the outbreaks becoming a reality before a vaccine becomes available, potentially resulting in borrowing requirements tightening due to heightened uncertainty. Finally, pre-COVID-19 geopolitical and trade tensions that continue to remain unresolved further exacerbate economic uncertainties.

As a result of the current environment, traditional private equity leveraged buyouts are side-lined due to pricing risk and ability to raise senior debt, while investors are seeking value acquisitions structured often as 100% equity deals. Strategic acquisitions are aimed at enhancing competitive advantage.

Long Term Market Themes

Although the world is currently immersed in dealing with the imminent challenges brought on by the COVID-19 outbreak, there are long term market themes —  both opportunities and challenges — that will stay relevant beyond the pandemic.

On the positive side, we are witnessing an ongoing demographic change leading to the intra-generational wealth shift between the so-called baby boomers and X generation and Millennials who exhibit a lack of the "next-generation mentality“. This will result in an increasing number of family-owned businesses and privately held companies coming to the market, opening up compelling opportunities to capitalise on this emerging long-term trend. Acquisitions will continue to be a key driver, while the professionalization of the Lower Middle Market that has been happening over the past decade will continue. The expectation is that capital will continue to be increasingly available, including debt at low interest rates.

On the negative side of the equation, the uncertainty as to what shape the economic recovery will take still remains, while the question of whether the lack of quality companies for sale will lead to stronger valuations for those that are still available. Finally, as the world is starting to emerge from the immediate pandemic shock, we are witnessing an increasing push for economic sovereignty, which may leave the de-globalized world economy in the post-pandemic world turning M&A markets more domestic-focused.

The Role of Advisors

As the world settles into the new normal where heightened uncertainty is the norm rather than an anomaly, companies and investors alike will start shifting their focus from dealing with short term pandemic shock to managing elements of mid and long term environments that will bring its own set of opportunities and headwinds. In a sort poll survey among our own advisors about the potential timeline of M&A recovery, the majority of respondents expect M&A activity to pick up in Q2 2021 (45.45%), while almost a third (31.82) expect the recovery to materialise in Q4 2021. In contrast, the most optimistic cohort that counts 13.64% of respondents holds that Q4 2020 will bring the expected pick up, while those on the most pessimistic end of the spectrum (9.09%) anticipate that we will have to wait beyond 2021 to see pick up in this space.

As the companies and investors are seeking to gain clarity in these unprecedented times, the role of strategic advisors is evolving to assist the clients in reimagining and remodelling their businesses, enabling them to navigate through these volatile times.

As highlighted by Anant Patel, HLB’s Global Transaction Advisory Services Leader, "This is the time for us as M&A consultants, accountants and advisors to help our clients navigate through these challenging times and reimagine their business, walking them through, asking questions about the change in the customer behaviour, supply chains and distribution channels and putting a short term and long term plan together.”


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