Are blue skies ahead for M&A deal-making in Australia?21 April 2020
Equity market conditions have undoubtedly changed over the past 8-10 weeks since COVID-19 created its initial tremors. The resulting severe market volatility has wreaked havoc, bringing much of the economy to a screeching halt. COVID-19 most certainly ravaged corporate share prices and redirected companies that otherwise would have engaged in M&A activity to look inward and focus on their own survival. Cross-border transactions have largely fallen away. Governments globally are being called upon for bailouts, to protect severely distressed companies from foreign acquisition, and to protect industries and key assets.
In amongst all of this, the current crisis has also seen many companies go from strength to strength. Companies in the biomedical space, such as ResMed Inc, have seen their share prices sky rocket, as demand for their respiratory medical apparatus increases.
There has also been a great deal of ‘pivoting’ in the market that has resulted in companies thriving. Companies that pivot quickly in order to fill a new demand in the market have already demonstrated success, even in the space of a few short weeks. An example of this is rapid blood test company Atomo Diagnostics, which has recently pivoted to supplying kits for COVID-19 antibody tests and made its debut on the ASX at a price that is reported to be more than double its initial public offering price.
As M&A lawyers and deal makers are coming to terms with the volatility, more and more opportunities to help our clients are coming to light.
Expected corporate activity—opportunistic deals
On one hand, there is still high value activity, such as substantial selldowns, taking place in the market. As recently as two weeks ago, Wesfarmers sold down a $1.1 billion stake in the supermarket group Coles, to shore up balance sheet flexibility and support its businesses through the current economic circumstances.
Private equity firms and big corporates in favourable industries have openly stated that they are in a position to snap up distressed assets and companies as soon as their crystal balls become less cloudy and they are able to make a better assessment of the lay of the land. They will start circling soon. Incredibly opportunistic deal-making and deal-making for survival is what we are likely to see more of coming through this pandemic.
Companies in a strong financial position will most certainly take advantage of the cheap debt that is currently available. The favourable, low-interest rate environments are more conducive to deal-making, even though financiers are likely to impose more stringent covenants for new debt facilities.
On the other hand, however, some other types of market activity have been declining. Cross-border transactions have taken a hit as governments globally focus on protecting their domestic companies from foreign takeovers. With effect from 29 March 2020, the Foreign Investments Review Board (FIRB) has reduced the foreign investment notification threshold down to $0, in response to the perceived risk of distressed local assets and businesses being snapped up by foreign investors at discounted rates. This measure is aimed at protecting assets and businesses that should remain local for the time being as a matter of national interest. This will no doubt have an impact on M&A activity for the short to medium term.
The most important gauge of corporate activity is consumer sentiment, which is reported to be at a 5-year low, but large investment banks such as Morgan Stanley, JP Morgan and others have now called the bottom of the market. It is widely reported that the US markets, in particular, have recovered remarkably well with S&P500 up more than 20% from 24 March. The FTSE 100 has also risen by similar levels from its March lows and the European indices are continuing to demonstrate bounce back.
The mixed sentiments and the market volatility are causing companies to tread carefully and act defensively for the time being. They will likely look to consolidation and defensive mergers for survival and growth. Additionally, as was the case during the Global Financial Crisis (GFC), there will also likely be more capital raisings (especially of the ‘low-doc’ variety) as ASIC’s new relief measures, which came into place in mid-March, are more heavily relied upon by cash-strapped companies looking for a way to pull through to the other side.
Stimulating times—opportunities for the trusted adviser
Once the dust settles on the ‘new norm’ and the market tremors are fewer and far between, M&A deals will pick up. As we know from historical crises, market mayhem breeds opportunities. Many of the super successful companies of the future will be borne out of this period. They may still be relatively small start-ups, with lower overheads and greater agility to respond to the current market conditions. Helping some start-ups navigate these times might see you partnering with a juggernaut down the track.
Periods of turmoil and chaos highlight the value of the trusted adviser. This is our opportunity to demonstrate to our clients that we are here for them, to help them navigate through the turbulence and come out stronger on the other side.
Some new, smaller mid-market level transactions are starting to turn their wheels, whilst larger deals have been put on hold. Many businesses looking to sell are requesting that their advisers help them with getting their ducks in a row for when markets stabilise. Helping those clients to become sale-ready, or conversely for buy-side clients, helping them to avoid value-destroying deals and shore up their balance sheets for when the time comes to swoop in and buy, will most certainly benefit the advisers when it comes to deal time. Advisers will be required to, among other things:
- help their clients better understand how to take advantage of the Government’s different stimulus mechanisms. Just over 2 weeks ago, the Government announced its $130 billion JobKeeper Payment Program to counteract some of the impacts of COVID-19. This brings the Government’s total stimulus into the economy to $320 billion, a figure reported by the Treasury to amount to 16.4% of annual GDP. The various Government stimulus mechanisms, especially in relation to taxation relief, are not straightforward and present advisers with the opportunity to help their clients navigate through the changes
- advise and support company directors to act early and proactively to avoid engaging in insolvent trading and effectively discharge their directors’ duties by, among other things, taking advantage of the COVID Safe Harbour mechanisms, which effectively place a six-month moratorium on insolvent trading liability in respect of debts incurred ‘in the ordinary course of the company’s business’
- advise in relation to FIRB applications, given the more recent FIRB changes which have come into play
- assist their clients to make the appropriate balance sheet adjustments
- help clients prepare a turn-around plan to navigate the current climate
- advise clients in relation to voluntary administrations that may be used, sometimes through a deed of company arrangement (DOCA) to restructure the company to emerge stronger or sell the company as a going concern, thereby more often than not providing better returns to shareholders and creditors as compared with an outright liquidation
- advise clients in relation to ASIC’s relief mechanisms aimed at entities unable to meet financial reporting obligations due to the impacts of COVID-19, and
- advise listed clients manage their disclosure obligations in light of the regulatory relief package released by the ASX.
The volatility that companies have experienced have no doubt resulted in regulatory and legislative amendments that companies focusing on survival will likely not have the opportunity to fully be across. This is the time when our clients need us the most.
The upshot—changes in sentiment emerging
This may feel like the GFC from over a decade ago now. However, it is not. This downturn was artificially created by governments in response to the pandemic, a flow-on effect being the creation of shocks within financial systems, whereas the GFC was caused by the financial systems themselves.
There were also lessons learned from the GFC that many companies, financiers and regulatory bodies have put into practice. Companies have taken a more conservative approach than before the GFC. They have better acknowledged the existence of market cycles and maintained more manageable loan to value ratios. The banking industry, following the Banking Royal Commission as well as the GFC, is now more heavily regulated and has adopted more responsible lending.
The upshot is that, once sentiment returns to the market following government control of the pandemic, the recovery will likely be faster than following the GFC.
Of course, one of the main factors impacting on market sentiment is ‘the COVID-19 curve’. Modelling data is finally positive, demonstrating that infection rates are now running well below expected scenarios. The flattening of the COVID-19 curve in Australia, at least, has had the positive result of demonstrating that although the pandemic is serious, it is manageable and that there will be a stabilisation of sorts over the upcoming months.
Incredibly, the newspaper headlines from just hours ago seem to be shifting: “Australia on track to eliminate virus”, “Four more weeks: PM says end in sight”, “Australia on course to eliminate COVID-19, modelling shows”, “Bidders line up as Virgin Australia clears the debt” and as the hours go on, there is more of this.
11 May 2020 is now set as the date for staggered returns for NSW schools to begin. The opening of schools will shift market sentiment, as it will demonstrate that the Government has a handle on the pandemic at least locally and things will begin to normalise again.
Importantly, although there are new figures and new reports coming out every single day, by and large China appears to be winning the battle against COVID-19. Life is returning to its once-deserted cities, people are returning to their jobs and the number of new COVID-19 cases are on the decline.
All eyes are on China, our Prime Minister and global markets but what appears to be emerging is that there is a slow and steady shift towards clear blue skies.