Current as of 17 March 2020
The rapidly developing global environment in the wake of the COVID-19 pandemic makes it difficult to pinpoint any trends that may be emerging from global PE deal activity or, indeed, to carry out a definitive assessment at this stage, of the impact on PE deal activity as a result of COVID-19. However, some initial observations (as of 17 March 2020) can be gleaned from the deals that Mayer Brown’s global PE group is currently involved in across our core markets of Asia, the US and Europe in the age of COVID-19 so far. This might hint at what’s to come as the situation continues to evolve.
In Asia, the widespread travel restrictions and related quarantine measures, the prolonged shutdown of government offices, and the significant business disruption caused by people being encouraged (or, in some cases, directed) by their employers to work from home due to the pandemic is having an increasing impact on Asia PE deal activity. Amongst other effects, we have seen some instances of COVID-19 causing delays in closing deals (particularly where transactions require regulatory approvals from government officials whose offices are temporarily closed) or causing difficulties in completing the due diligence process (especially where site visits or in-person meetings are required), as well as prompting some PE investors to postpone prospective deals until the situation improves. In Asia, such impact has been particularly seen on transactions involving China where COVID-19 has had the most serious impact in Asia to-date.
In the US, measures to slow the spread of COVID-19 have been rapidly intensifying, with “social distancing” now widely adopted nationwide and an extensive and growing number of school and business closures throughout the country. With the response to COVID-19 now affecting business activity in many sectors of the US economy and daily life, we find that many PE clients are still, at this point, focused on the immediate actions to be taken by their existing portfolio companies, including employee health and safety considerations, contingency and response planning, supply chain and commercial contract fulfilment issues, communication plans, IT facilitation of remote working, reduction of fixed costs wherever possible, and liquidity needs. The effect on PE deal activity is rapidly evolving. To date, we have seen that recently signed/exchanged deals, with committed debt and equity financing, are still proceeding to closing or are expected to get there, recognising that regulatory approvals may be delayed, including because the FTC/DOJ has stopped granting early termination of the HSR 30-day pre-acquisition waiting period. However, where deals are still in negotiation, and especially where due diligence is ongoing or has not yet begun, clients are expecting significant delays in the deal process. As in Asia, inability to conduct on-site or in-person due diligence has been a leading factor in many clients’ decisions to put deals “on hold”. Given predictions of slowing or negative US growth over the next six months (e.g., Goldman Sachs predicting zero US growth in Q1 and negative 5% in Q2 with a strong rebound later this year), many US PE investors are taking a “wait and see” approach to investments. Some sectors of the US economy (including oil and gas) are facing immediate challenges that have made M&A deals hard to price.
In the UK, Boris Johnson has now encouraged people to work from home. Large public gatherings have been postponed and the immediate economic impact is worrying for many. A prime target for immediate concern is the leisure and travel industry, and with closures and significantly reduced demand, there will be implications for trade suppliers of relevant goods and services.
In France, the message we’ve been getting from most PE funds and investment banks is that transactions that have been signed recently should, in most cases, proceed to closing. By contrast, PE transactions that were about to be signed around the time the COVID-19 outbreak escalated into a pandemic have, in many instances, been suspended due, in particular, to the decision of the credit committees of the main banks to stop approving the financing of new PE transactions until further notice. In addition, most PE funds are currently reviewing the level of cash available at their portfolio companies to ensure that they can still operate despite a drought of external financing and to anticipate distressed scenarios.
In Germany, the COVID-19 situation has rapidly accelerated during the last few weeks resulting in a near shut-down of daily life that has impacted the economy and deal flow. Following a moderate start into 2020, which was characterized by large-cap transactions and public M&A deals, overall deal activity has significantly slowed down recently, in particular, since meetings with potential targets, management presentations or signings have been postponed due to quarantine measures. Furthermore, the latest crash on stock markets and unpredictable short-to-midterm economic situation have contributed to investors’ reluctance to conduct transactions (in particular at high purchase prices/EBITDA multiples) and might re-shift their focus to look for stable assets in more resilient sectors that are less likely to be affected by pandemic situations (e.g., technology sector, infrastructure). In any event, these days PE funds are predominantly focusing on their portfolio companies to mitigate any damage to their businesses as well as employees, and are actively working on crisis management and contingency planning. In this regard, the German government has indicated that it will provide significant and swift financial support to ensure companies survive the pandemic and protect their workers from its impact (e.g., through loans granted by the reconstruction loan corporation or deferment of tax payments).
Depending on how the COVID-19 situation evolves over the next few months, it is likely that the pandemic will refocus PE investors’ attention on the increasing importance of provisions such as “material adverse effect” (MAE) clauses and “force majeure” clauses. PE investors who may be exiting a portfolio company via a sale process are likely to want to negotiate more specific carve-outs from MAE clauses to prevent events originating from COVID-19 from constituting an MAE (with specific references to COVID-19, epidemics and pandemics being included as carve-outs from the circumstances which would trigger an MAE). Conversely, PE investors who may be on the buy-side of a sale process might insist on a clear walk-away right from the deal if the business suffers a materially adverse (even if only short term) impact due to COVID-19.
As the uncertainty surrounding the impact of the COVID-19 pandemic makes valuation particularly challenging in these circumstances, PE investors may also be more inclined to give closer consideration to provisions in deal documents relating to the purchase price and adjustments to it. For example, where a locked-box mechanism is used to value a target company in an industry sector or geographic location that is significantly affected by the pandemic, investors may prefer to switch back to the more traditional completion accounts/working capital adjustment mechanism in the transaction documents, to limit their risks in declining working capital.
In the current COVID-19 environment (and possibly in the post-pandemic world also), PE investors may also be inclined to undertake more detailed due diligence on certain areas such as a target company’s supply chain dependency, to understand the geographical scope of their operations and how that might be affected by COVID-19 (or other events in the future that could cause similar seismic disruptions to business), as well as an increased focus on reviewing the target’s key commercial contracts to assess parties’ ability to terminate as well as the scope of any force majeure clauses.
The global landscape in the age of COVID-19 is in a state of flux and remains constantly fluid at this stage. We have no crystal ball with which to accurately predict the overall impact that COVID-19 will eventually have on global PE deal activity, or any lasting effects that the pandemic may have on the global PE industry generally once the masks have all come off. Much like the daily updates of COVID-19 infection and recovery figures being released each day by countries around the world, it is only possible at this stage to wait and see how the global PE deal landscape evolves with each new day, and continue to hope (as we all do) that business, and life, return to normal again soon.