Private Equity Response to COVID – Accelerate Add-ons

Corporate Development

June 2020 — By John Mathis


The catastrophic economic downturn of 2020 has wreaked havoc within the Private Equity (PE) investment world for existing portfolio companies. The hardest hit operators have cut costs, shifted to virtual operations and drawn down lines to protect their cash positions.  

Currently, the PE investor faces an uncertain recovery curve for their portfolio companies. This is mainly a result of three particularly tough headwinds:

  1. “New normal” mutations in the post-COVID business model – Trends that already existed pre-COVID such as automation, digitalization, and business model resilience, have now rapidly accelerated and will continue to do so.
  2. Downward pressure with widening variance to private company market multiples – In the 2008 downturn M&A volume and valuations declined roughly 25% and did not return to pre-recession levels for nearly 2 years. 
  3. Elongated hold periods for Private Equity – In the alchemy of investing, regaining IRR threshold performance is a mix of financial agility and finding ways to reignite growth while market multiples recover.  The math of add-on acquisitions becomes one of the most powerful antidotes for regaining lost time, as we highlight in historical data below.

Lessons from the Past

A Harvard Business Review analysis of the 2007-2012 period before the previous downturn and into the recovery noted the competitive advantage gained by acquirers that remained active: 

“Evidence from the global financial crisis from late 2007 through early 2009 shows that companies that made significant acquisitions during an economic downturn outperform those that did not.”

The Case for M&A in a Downturn, HBR, May 17, 2020

Their analysis suggests more than a 3X outperformance for the “Active Acquirers” through the downturn, clearly illustrating the power of continued acquisition.

Active Acquirers Outperformed Their Way Through the Last Downturn

Total Shareholder Returns 2007-2012

source: The Case for M&A in a Downturn, HBR, May 17, 2020

Transforming Challenges into Opportunities

Catalyst for Corporate Development - Our buyside practice is growing as clients seek a fast action team with a methodology and track record of great outcomes.  We are adapting our practices to better respond to a post-COVID world.  Below, we highlight four new M&A lessons that we are navigating in real time.

1. Switching to offense, our turnkey add-on pursuit practice – Our firm’s “buy-side” sourcing and execution practice is focused on private equity backed strategics in technology-enabled business services.  This year, we have launched several new client engagements focused on the tactics outlined above, and notably, all are tracking better than pre-COVID expectations.  Our PE clients are on the offense and expect Harbor View to add M&A bandwidth to enhance their competitive advantage through sourcing and executing of add-on acquisitions.  We deliver outcomes along the diagram below.

Harbor View's Catalyst for Corporate Development Process

 

2. Surprising CEO/founder response rates – We’ve found the strongest indicator of M&A potential is response rates to our sourcing work.  We expected COVID to hurt our response rates, however, we have seen the opposite.  In one assignment launched in the midst of COVID, we’ve had 70% initial response rate – versus our normal run rate of 40%.  As the chart below shows, on average, our engagement response rates are running nearly 20 percentage points higher today.  Why?  We hypothesize a mix of drivers including the obvious: concern about outlook and declining market multiples creating a sense of urgency; and less obvious, an increase in CEO at-home availability.

 

3. Deal adjustments to structure and value – We’ve seen a wide variety of responses to the market and new normal conditions. As one wise PE partner put it: “…getting back to 100% of pre-COVID value will require significant effort. And it is not a certainty. Perhaps starting at 75% and moving to a hold-back or earnout can get us there – so much depends on the end-market.” Notably, we have seen the public markets recover nicely, including the key Technology and Service sectors we focus on (highlighted below), with Software stocks up 36% year over year.  Anecdotally, however, private company markets seem more mixed.  Our sell-side clients are all experiencing some adjustment to deal terms, however, in two cases, valuation has the potential to come in above pre-COVID expectations.

 

4. Virtual processes of discovery, due diligence, and integration from behind a mask – Our clients and the workstreams we are facilitating with them are taking full advantage of Zoom, Microsoft Teams, and other tools like Slack.  We expect accelerating technology penetration from firms like Knowable, whose AI powered software accelerates the contract review process. The lesson everyone is learning is how to adapt from a physical to a virtual “deal culture.” Staying disciplined is key – particularly during a crisis. Intralinks and DealRoom hosted virtual sessions where M&A practitioners are clearly energized and are getting deals done while leaning on technology – for example, how to assess cultural fit remotely?  Online assessment surveys. Of course, it helps that data rooms were already virtual.

Summary

Many of our Private Equity backed clients have been early responders to the COVID-induced challenges and are looking for ways to create new advantages. The Harbor View team is ready to help with turnkey M&A services that provide either high potential target sourcing or full transaction execution. 

The HBR authors summed up the current challenges and opportunities nicely: 

“History suggests… that there will be a relatively short M&A window that opens as the Covid-19 crisis ends, during which bargains will be had by those with the liquidity and the risk tolerance to move quickly, and who have done their homework in advance.”

The Case for M&A in a Downturn, HBR, May 17, 2020

Sources:

  • EY, PE Pulse, April 2020 “Quarterly insights and intelligence on PE trends.” 
  • Fidelity, June 2019-2020, “U.S. Sectors & Industries Performance”
  • Intralinks, June 16,17 and 18, “Virtual M&A Summit”
  • M&A Science Virtual Summit, DealRoom, June 10-11, “Keeping Teams Aligned during M&A Integration”
  • The Harvard Business Review, May 17, 2020 – “The Case for M&A in a Downturn”

DISCLAIMER: This presentation is intended for information and discussion purposes only and does not constitute legal or professional investment advice. Statements of fact and opinions expressed are those of the participants individually and, unless expressly stated to the contrary, are not the opinion or position of Harbor View Advisors, LLC (“HVA”). The information in this presentation was compiled from sources believed to be reliable for informational purposes only. HVA does not endorse or approve, and assumes no responsibility for, the content, accuracy or completeness of the information presented.