Published in Finance

Virus concerns drive additional due diligence in M&A transactions

BY Sunday, March 15, 2020 07:00pm

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The coronavirus outbreak that’s battered Wall Street and caused supply chain disruptions for some manufacturers has yet to interrupt transactions, although more conversations are occurring as part of due diligence, according to M&A professionals.

Left: Mike Brown of Charter Capital Partners LLC, right: Scott Hill of Varnum LLP COURTESY PHOTOS

In interviews last week before the declaration of a national emergency, experts told MiBiz that deals that are in process involve a deeper dive into due diligence in situations where one company is acquiring another that sources raw materials or components from China. Buyers are asking for more information about supply chains, backup plans and the capabilities of replacement suppliers. 

“It’s still very new. Everyone’s trying to figure it out on the fly, but if clients were selling source parts from China, you’re going to have to make sure they have a backup supply-chain plan in case there is a major disruption,” said Mike Brown, who leads the M&A practice at investment bank Charter Capital Partners LLC in Grand Rapids.

On March 10, Gov. Gretchen Whitmer announced the first presumptive positive cases of coronavirus in Michigan, in Oakland and Wayne counties.

Brown describes a situation in which one client under a letter of intent that sources a small product from China for its biggest customer had to arrange for a backup supplier in the U.S. that’s more expensive. If the company has to switch to the backup supplier, it would generate less margin for the business, a potential downside in the deal that required pricing out the margin difference during due diligence, he said.

“It’s a little more work for everybody,” Brown said. “If we have a domestic client that sources everything domestically, it’s a plus.”

Due diligence in any deal typically involves questions about a seller’s top suppliers, according to M&A professionals.

Amid the outbreak, diligence has been going further and into indirect ties to the supply chain of a supplier, experts said. As the outbreak evolves, deals may take more time and move a little slower.

“Any time you have an episode like this, it’s going to extend that. More questions are asked,” said Scott Hill, a partner in the corporate practice team at Varnum LLP in Grand Rapids. “You always ask about your top 10 suppliers. Do you have sole-source suppliers? Now it’s more of a geographic reach. It’s not just a numbers game of where the supply is coming from. It’s, ‘OK, which countries? Have you had an impact? What’s your inventory level? We’re actually going to do a full inventory now.’ And those things take time.”

No real slowdown

Sellers are not the only ones asking more questions in due diligence, Brown said. Banks that are involved in financing deals also now want to go deeper into a seller’s supply chain and backup plans.

“They’re going to want a downside scenario. ‘All right, what happens if you have to shut down for a month? Or if you can’t get this part for a month? What does that mean for our credit exposure?’” Brown said.

At law firm Honigman LLP, “we have not seen any real impacts” on domestic M&A from the outbreak in terms of deal flow in the middle market, the timeline to get deals done or in financing, said Tracy Larsen, managing partner of the firm’s Grand Rapids office.

The outbreak may potentially slow international deals because of travel restrictions, Larsen said. 

While there are more questions during due diligence for companies that source from China, “we just have not seen any real slowdown” in deal flow, “even in manufacturing where significant components come from China,” Larsen said.

Investment bankers and commercial bankers that Larsen talks to regularly share that view, he said.

“While it gets talked about a lot, there’s not really any impact on domestic middle-market M&A. Banks appear to be open for business and aggressive to lend, and the rates have gotten better. We’re still anticipating a very significant year for transactions,” Larsen said. “At this point, the discussion has been more from a planning perspective and a general interest perspective than people actually trying to get out of transactions or get out of financings because of the virus.”

‘Be prepared’

The bigger issue is whether the outbreak becomes severe enough in the U.S. that it weighs down the economy and results in tighter credit that would affect M&A and real estate transactions and business operating lines of credit.

In a March 9 updated outlook, Comerica Inc. called February a “turning point” for the U.S. economy. Findings for March “will begin to show us the impact of the global coronavirus outbreak on the U.S. economy,” Comerica economists wrote in the updated outlook that assumes a further lowering of interest rates.

Comerica raised the chance of a U.S. economic recession within six months to 40 percent, and to 45 percent within 12 months.

“We are forecasting very cool, but positive, growth for the U.S. economy through the first half of 2020. We expect to see an above-trend rebound visible by early 2021. However, it would be an oversell to call it a V-shaped recovery,” according to the outlook.

In a joint statement issued March 9, five federal agencies urged lenders “to meet the financial needs of customers and members affected by the coronavirus.”

“The agencies recognize the potential impact of the coronavirus on the customers, members, and operations of many financial institutions and will provide appropriate regulatory assistance to affected institutions subject to their supervision,” according to a statement from the Federal Reserve, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corp., the Consumer Financial Protection Bureau, the National Credit Union Administration and the Conference of State Bank Supervisors.

Hill at Varnum said the coronavirus outbreak has been used “as an excuse” in one transaction to delay financing.

Amid the economic fallout from the outbreak that has spread to the U.S., “a dose of caution is important here,” Hill said.

“This is an opportunity to be prepared,” he said, “and if you’ve done good planning ahead of this, you’re certainly more well positioned than others.”

Read 4852 times Last modified on Friday, 20 March 2020 17:37