The M&A market that slowed in the first half of 2020 with the onset of the COVID-19 pandemic should rebound well over the next 12 months as deals that got put on hold go forward, according to a midyear survey by law firm Dykema Gossett PLLC.
A little more than half of the 105 corporate executives and M&A professionals surveyed told Dykema in June that they expect the market to strengthen through the rest of the year and through the first six months of 2021. That higher activity could occur after a weak first half of 2020 when the U.S. economy fell into recession.
Just 35 percent of respondents expect the market to weaken and a little more than 14 percent see no significant change through midyear 2021, according to the survey results.
“The M&A market got slowed down by COVID-19 and has started a slow recovery,” said Tom Vaughn, a partner at Dykema’s Detroit office and co-leader of the law firm’s M&A practice group. “Most people have just paused (transactions), they haven’t stopped. That would be consistent with some expectation of an ability to restart activity, particularly later in the year as we, hopefully, get our arms around COVID-19 and we get some stability.”
The Chicago-based Dykema annually surveys corporate executives and M&A professionals in the Midwest and around the U.S. in the fall and uses the results to issue a market outlook for the coming year. Given the market disruptions from COVID-19, Dykema conducted a survey in June that asked for views on the next 12 months and gauged the pandemic’s effects.
Results of the survey — conducted with Association for Corporate Growth chapters in Detroit, Columbus, Ohio, and Austin and San Antonio, Texas — indicate that executives and M&A professionals have higher-than-expected confidence in the economy and that valuations are coming down, which could keep some prospective sellers out of the market.
Survey respondents told Dykema “most dealmakers have taken a wait and see approach” to transactions. Deal flow was affected by delayed negotiations and due diligence, reduced transaction valuations and termination of purchase agreements, according to survey results.
As a result, the pandemic “has increased the appetite for future acquisitions,” Dykema said in a report on the survey results. More than six out of 10 respondents believe their company or one of their portfolio companies would make an acquisition within the next year, and a little less than one-third told the law firm they believe they would sell a business.
“That is a good sign for M&A activity. M&A has been really quiet for the first six months of the year,” Vaughn said.
The higher interest in M&A is “very consistent with what we are seeing anecdotally and when I talk to people,” Vaughn said. “In recent weeks, people are seeing a start of M&A activity. People are starting to pick up deals again and are looking at deals again in a way they weren’t a month or two ago.”
Mike Teeter, managing partner at Spring Lake-based M&A firm InVictus LLC, expects that pent-up demand will partly drive the deal flow in the second half of 2020 and first six months of next year.
Activity for InVictus began picking up in June, Teeter said. He’s been seeing higher interest as well from private equity firms looking to make an acquisition and deploy their capital.
“There’s money out there and they want to deploy it. They have to go somewhere with that money, the question is what are they going to deploy it in?” Teeter said.
“I don’t think we’re going to see the deal flow that we normally would if we were not going through this (pandemic), but I think we’re going to see some pent-up demand taking place and that money that’s on the sidelines is going to start to get deployed,” he said.
Private equity deals decline
One indicator of the M&A market’s decline comes from a quarterly report Pitchbook issued last week on private equity activity.
Private equity deals declined nearly 20 percent in the first half of 2020 from the same period a year earlier to 2,173 deals, according to Pitchbook. Transaction values decreased about 20 percent for the first half, and were down by nearly a third in the second quarter alone.
Deal flow through the rest of 2020 will depend on whether restrictions continue to ease, said M&A attorney Jon Siebers of Rhoades McKee PC in Grand Rapids. If an easing of restrictions gets paused and the more severe pandemic measures are back in place, “it’ll slow down deal flow more,” Siebers told MiBiz in late June.
MiBiz recently reported how M&A activity in the small business market has been affected by a reluctance of some sellers to come to market right now, even amid strong demand from prospective buyers.
More than half of respondents to the Dykema survey cited the state of the U.S. economy as the top driver of M&A activity into next year. The economy was cited as the top driver by one-third of respondents in the annual Dykema survey last fall.
The pandemic has “not significantly tempered” expectations for U.S. economic performance from the results last fall, when respondents were about evenly split in their views. In the mid-year Dykema survey, a little more than one-third held a positive outlook for the economy, and 30 percent were negative. The other 36 percent were neutral on the economy.
Longer term, 76 percent of survey respondents said they held a positive outlook on the economy for the next 24 months. Just 5.7 percent had a negative outlook on the economy and the remaining were neutral.
For sellers who are waiting for the economy to recover before coming to market, the 12- and 24-month outlooks indicate they can probably get more for their business a year or more from now, Vaughn said.
“If you as a business can survive through the next year, there is light at the end of the tunnel,” he said. “If you are a seller and you think you can hold off for a year — you’re not distressed, you can sustain the business for a period — you probably are better off sitting on the sidelines because the economy should be better. Valuations are down now and you have a better shot at getting that valuation you were hoping for and looking for.”
Nationally, Comerica Inc.’s latest economic outlook projects U.S. Real GDP growth of 12.3 percent in the present third quarter after an estimated 24.7 percent decline in the second quarter. The U.S. economy will grow another 3.6 percent in the fourth quarter and then start 2021 with a quarterly growth rate of 5.9 percent in Real GDP, according to an updated outlook Comerica issued July 6.
PNC Bank in June projected third quarter Real GDP of 13.9 percent, after an estimated 30 percent decline in the second quarter, and 8.1 percent in the fourth. PNC projects 2021 to begin with 5.8 percent Real GDP growth in the first quarter.
Nearly 23 percent of respondents named valuations as the second-largest driver of deals. That’s more than four times the number of respondents who cited deal valuations back in the fall.
That finding reflects how a large majority — 82 percent — expect deal valuations to decline in the next 12 months, driving an increase in deal flow. In the fall survey, a little more than six out of 10 respondents expected a decline in valuations during 2020.
Sixty-three percent of respondents also felt that seller expectations on valuation “is an impediment to getting deals done,” likely leading to sellers waiting to come to market until the economy improves and more focus on distressed deals over the next year, Vaughn said. The exceptions could come in companies with “the right technology” in the pandemic that a prospective buyer may find attractive.
The mid-year survey also found the higher use of earnouts and delayed payments.