Implications for M&A Transactions
By Stéphane Pithois
Extended periods of volatile economic and market conditions have been shown to reduce M&A activity. As the coronavirus disease 2019 (or Covid-19) plagues the world, sectors such as manufacturing, tourism, energy, retail and transport are hit hard by the loss of revenue.
Compared to the same period last year, there is a significant decrease in global M&A activity in 2020 and according to data provider Dealogic, the global M&A market is already set for its slowest first two months of a year since 2005.
This article seeks to discuss some of the implications and key considerations for M&A transactions within the context of Covid-19. We have set out a list of relevant tips to help interested parties navigate this unprecedented period.
During such uncertain times, both parties need to consider a wider array of scenarios when deciding on a transaction, especially if the target business has dealings in countries with different level of impact at a certain point in time. Therefore, it is imperative to dedicate more effort on fact-gathering to avoid an adverse outcome.
Each deal has its own unique considerations, but ensuring a specific focus on the following aspects would be recommended:
REVENUE AND SALES PERFORMANCE
The outbreak has officially been characterized as a pandemic by the World Health Organisation on March 11. Revenue and earnings forecasts for affected jurisdictions will likely be hit with negative effects, and a large number of companies, both public and private, have revised their 2020 budget downwards. Earnings being often a critical element in any deal valuation, (irrespective of the aggregates used by the buyers e.g. revenue, EBITDA or net profit), sellers should be vigilant of buyers who may attempt to use Covid-19 as a bargaining chip. Sellers should also invest time in forecasting any scenario once the overall economic environment hopefully goes back to a more stable situation.
However, it is still to be seen how transactions entering the negotiation phase will play out. The reach, duration and extent of the outbreak will contribute towards the leverage a party may eventually have over the other. Depending on financial market conditions, the buyer may also face some challenges or delays when looking for funding of such M&A transactions.
RISK OF INSOLVENCY AND BREACH OF CONTRACTUAL OBLIGATIONS
With asset values at risk of falling substantially, does the target require an urgent capital injection to keep the business afloat, including prior to any deal completion? Could the disruption lead the target to not being able to fulfill some of its contractual obligations (e.g. any condition precedent set forth in a share purchase agreement)? Minimizing the costs that can result from possible breach of contract is a key concern for all parties.
Buyers and Sellers should stay vigilant and request transparency during discussions. Sellers should study all acquisition documents carefully, including side letters. It is also standard practice for buyers to include a clause called material adverse change (“MAC”) or material adverse effect (“MAE”). MAC serves to protect buyers against unforeseen changes to the target – Covid-19 in this case – allowing them to terminate the transaction if the situation materially deteriorates.
However, MAC is not entirely enforceable as the onus falls on the buyer to prove what reasonably constitutes a material change, or if the target experiences a drastic material change. Heavy negotiations are expected depending on how the clause is specifically worded and may lead to litigation situations, in case the parties are unable to agree on equitable thresholds and criteria for such assessment.
Although buyers can gain protection hence introducing some mechanisms (that would also imply some termination costs), sellers can also include reverse termination fees should the buyer walk away. Lastly, in most acquisition agreements, an “outside date” or “long stop date” provision enables termination if the transaction does not close by a specified date.
BUSINESS CONTINUITY PLANNING (BCP)
Is the target business taking steps to ensure that its personnel and assets are protected during this period of disruption? Are alternatives such as remote working explored? Are there any insurance policies in place to mitigate the risks arising from the disruption and would these be activated given this unique situation?
While safeguarding the health of the organization is paramount, secure employment in the hardest hit sectors will be another decisive issue.
IN-PERSON MEETINGS AND INSPECTIONS
Managing expectations and communication with stakeholders are especially crucial in such uncertain times and the unpredictable evolutions regarding travel restrictions and strict quarantine measures are challenging any M&A process planning. Physical site visits and management meetings are restricted or completely prohibited.
While this can make doing business difficult, some of these hurdles may be addressed by the reliance on virtual data rooms and video conference calls that can be easily deployed to facilitate the diligence process. Harnessing technologies at hand can ease the pain points for both parties, even more so when dealing with multi-jurisdictions deals as it is often the case for M&A in Singapore.
It is always helpful to bear in mind that no position is wholly favourable towards the seller or the buyer under the current situation. As this situation continues to unfold, we can anticipate more implications for M&A transactions and all stakeholders will be required to show agility and creativity to still seize opportunities.
HOW WE CAN HELP
Our teams are currently working on the execution of transactions: this includes providing local temporary support to the in-house M&A teams of our clients for deal execution and negotiation, when overseas buyers are prevented from travelling to some countries.