M&A Trends Before the Coronavirus (COVID-19) Outbreak
Global M&A activity in 2019 was strong once again, finishing just 3% lower than 2018, making 2019 the fourth strongest year for M&A activity since 1980. In 2019, the stock markets rose to new highs and private equity firms raised record funds. Companies searched for growth and solutions to technological and other disruptions. The value of M&A deals in the United States rose in 2019, with healthcare, technology and energy being the most active sectors, accounting for about half the overall volume.
Prior to the outbreak of the coronavirus (COVID-19), US companies had a slightly dimmer outlook on M&A activity in 2020 versus 2019, according to surveys of CEO’s by Deloitte US and PwC. Despite this outlook, US executives were generally confident about the prospects for revenue growth in 2020. M&A deals were expected to play a major role in many companies’ growth plans by managing the right combination of divestitures and acquisitions. Morgan Stanley projected a robust 2020 M&A market, driven by a strong US economy, an eventual reduction in geopolitical uncertainty, low interest rates and financially compelling acquisition opportunities. More than half of US executives confirmed that they planned to pursue M&A transactions to generate growth during 2020. Before the impact of the COVID-19 outbreak, there was plenty of affordable capital accessible to fuel M&A deals.
Impact of Coronavirus (COVID-19)
Despite strong M&A activity in the USA in 2019 and initial optimism for 2020, COVID-19, which, as of 11 March 2020 has been classed a pandemic, raises a number of serious concerns and questions about the economy in general and M&A activity in particular. COVID-19 has already negatively impacted businesses and supply chains around the world. From the last week of February and into March, the S&P 500 index suffered its worst loss in over 30 years, as investors worldwide grew increasingly fearful that the impact of a COVID-19 outbreak may lead to a recession.
The steep market drop, triggered in part by concerns related to the COVID-19 outbreak, led many companies to at least temporarily pause and assess M&A transactions. Even with the uncertainty of the presidential election in November, corporate advisors and executives previously predicted another good year for M&A deals in 2020, but the evolving risks to economic activity posed by COVID-19 makes it challenging to predict full-year M&A activity with any degree of confidence. Market volatility is generally a negative factor for M&A deals because it makes it more difficult to determine whether it is a good time to acquire or divest. M&A activity for the first two months of 2020 was the slowest it has been since 2005, due in part to deal delays as well as outright cancellations.
The impact of COVID-19 on global supply chains and consumer behavior has prompted many US companies to revise expectations downward. The full impact of COVID-19 on the global and US economies is yet to be determined and is very difficult to assess. Each day brings new developments that cause greater concerns and disruptions in daily activities. School systems and universities are sending students home for the remainder of the school year and professional and college athletics have suspended all activities for an indefinite period or canceled them altogether.
It is not too difficult to envision major employers in the USA requiring their employees to work from home, or seeing state and local governments recommending or mandating quarantining to limit the spread of the COVID-19 virus. As the number of COVID-19 virus cases in the USA grows, the pressure on the healthcare system could become overwhelming, requiring healthcare providers to triage all patients just to survive.
Ultimately, it is impossible to attempt to predict how COVID-19 will play out in M&A activity in 2020. However, it has already had a negative impact on M&A activity in the USA, and experts believe that the USA has yet to feel the full impact of COVID-19. Consequently, it is likely that 2020 will see a reversal of the robust M&A activity seen in recent years. The real question is whether the rippling effects of the COVID-19 virus will trigger a major recession and impact M&A activity beyond 2020.
In 2003, the SARS virus claimed around 800 lives worldwide and reduced China’s growth by about 1% when it was the world’s sixth largest economy. Today, China is the second largest economy behind the USA, and analysts are forecasting slowed growth for China in 2020 due to COVID-19. The widening scope of the pandemic threatens to overwhelm global supply chains, especially in China. The longer it takes for manufacturing production in China to return to normal levels, the greater impact the virus will have on the global economy and M&A activity.
As fears grow regarding the impact of the COVID-19 virus, financial markets have plummeted. There are now signs that the virus is impacting the real economy. COVID-19 is affecting consumer demand as people self quarantine, limit or cancel travel plans and alter spending in other areas; people are not eating out, not buying a new car, and canceling vacations. No one will know the true economic impact for some time, because the first estimate of GDP growth in the current quarter will not appear until 29 April 2020.
On 27 February 2020, analysts at Goldman Sachs predicted that S&P 500 companies would likely generate no profit growth this year because of the virus, which they predict will cause a serious slowdown in the Chinese economy, disruption in the supply chain for American companies and a slowdown in the US economy. Several major US companies, including Microsoft, United Airlines, Mastercard and Pfizer, have announced that the virus and ensuing disruptions to the economy poses a threat to their 2020 earnings. The extent of the damage will depend on how quickly the virus is contained, the steps authorities take to contain it, and how much economic support governments in the USA are willing to deploy during the epidemic’s immediate impact and aftermath.
According to the Center for Strategic and International Studies, early indications of COVID-19’s impact on the Chinese economy are worse than initially forecast. Surveys of China’s manufacturing and services sector plunged to record lows in February, and China’s exports fell 17.2% in January and February. Many analysts now predict a drop in first quarter GDP, the first contraction since China began reporting quarterly data in 1992. As COVID-19 spreads, China’s economic recovery will be challenged as demand from other countries, especially in the USA, drops as they cope with the virus.
Some analysts are forecasting a contraction in US GDP in the second quarter of 2020. Bloomberg Economics warns that full-year GDP growth could fall to zero in a worst-case pandemic scenario. In the USA, tourism, restaurant and travel-related industries are expected to be among the hardest hit as authorities and employers encourage self-quarantining and consumers stay indoors.
Because the severity and duration of the outbreak cannot be ascertained at this time, it is impossible to predict with any degree of certainty the full impact the crisis will have on M&A activity in 2020.
Other 2020 Challenges
While there’s both demand for deals and capital to finance them, there’s an increasingly complex business environment due to, among other issues, increased cyberthreats, expansion of data privacy laws, global trade tensions and shareholder activism.
Cyberthreats are now at the top of the list of serious concerns by corporate executives — over trade conflicts and geopolitical tensions. At the other end of this spectrum are concerns about over-regulation, especially in the areas of cybersecurity and data privacy. Security experts have determined that hackers proactively monitor M&A deals within specific industries, especially technology. Because most security breaches typically aren’t discovered until several months after the initial breach, this delay, along with the uncertainty of knowing whether a problem even exists, complicates M&A deals.
Companies interested in pursuing M&A deals must remain current with all of the significant changes in privacy laws in the USA and other countries in order to weigh the impact on the value of a potential transaction and to implement the appropriate compliance procedures. These issues affect data-driven companies to the greatest extent, but all companies are impacted to some extent.
M&A litigation shifted in 2019 from Delaware state court to federal court, with more focus on disclosure issues than on fiduciary issues. Such litigation remains an integral piece of almost all public and some private M&A transactions. Shareholders continue to seek access to corporate books and records – through litigation if necessary. Almost one-half of activist stockholder actions in 2019 focused on M&A transactions, which was nearly a 33% increase over 2018.
President Trump is expected to continue to use his executive power to block potential transactions, and the Committee on Foreign Investment in the US (CFIUS) is expected to continue to be active in blocking transactions. In January, 2020, CFIUS published final regulations that expand the existing “pilot program” to cover, more broadly, foreign investments in US businesses performing critical infrastructure functions – which include more modern security concerns, such as internet protocol networks and exchange points, data centers and core processing services for federal financial institutions – and collecting sensitive personal data pertaining to US citizens.
Even if COVID-19 was not wreaking havoc on the Chinese supply chain and world and USA economies, it is unclear what impact the ongoing trade dispute between the US and China will have on the Trump administration’s national security policies or whether new legislation will be proposed. The recent signing of a “Phase 1” trade agreement with China could alleviate some of the trade tensions and could result in a broader trade agreement, but the administration’s national security concerns pre-date the trade war and are likely to continue to impact the M&A deals.
Many experts believe that the biggest M&A challenges in 2020, other than the COVID-19 crisis, will be geopolitical and macroeconomic factors, including potential economic downturns, the 2020 US elections and the USA-China trade dispute.