We are in the third quarter of 2020 and deal data is now available through the end of the second quarter 2020. In this report, we review our region’s most active industry sectors and offer an outlook for Fall 2020.
For the second quarter in a row, we are focusing our Mergers and Acquisitions analysis on the outlook through the upcoming six months. We now have data to back up our initial insights into the COVID-19 impact on the U.S. economy, specific industry sectors and the outlook for M&A. As forecast in our previous recent quarterly report, short-term declines were indeed seen across all sectors in this report, with many acquisitions hitting pause.
Even for motivated acquirers, most diligence and transaction closings would typically require air travel. As in every industry adapting to change, technology tools allow us to adapt and accommodate this new environment. On the bright side, from our ClearRidge perspective, deals that were paused a few months ago are now back on track for closing before year-end, in most instances with robust valuations that mitigate COVID losses.
Surprises for a private company acquisition during COVID-19
For owners of a founder-owned privately held company, there continue to be opportunities to sell for strong valuations. There are few companies available to merge or acquire right now, which means greater attention for every business owner willing to discuss an acquisition. This supply demand imbalance is yielding higher attention for companies that are performing reasonably through COVID. Not only higher valuations, but increased attention and prompt review, diligence and closing.
There is also broad optimism that the return to normal will begin through the end of 2020 and into 2021. Furthermore, acquirers understand the impact of COVID-19. Private company acquirers partly attribute valuation to the trailing twelve months of EBITDA (Earnings Before Interest Tax Depreciation and Amortization). Current best practices, however, allow for EBITDA+C (+COVID), i.e. allowing for performance adjustments through COVID. A buyer will want to see the beginning trajectory of a business’ recovery from COVID but is willing to credit pre-COVID performance and a clear path to return to that performance. There are also deal structures and timing that can bridge the COVID period.
Sector by Sector
In these seven sectors below, we highlight some industry-specifics related to mergers and acquisitions activity.
Commercial aerospace is among the most deeply impacted sectors from COVID-19. However, the challenges extend to all sectors of aerospace and defense. Two notable deals fell victim to the impact of the pandemic. Boeing’s acquisition of Embraer’s commercial aviation and Woodward’s merger with Hexcel were both terminated.
Deal volume increased 14% in the first half of 2020 compared to the 10-year average but was down 17% versus the first half of 2019.
Boeing, United Technologies, Lockheed Martin, GE Aviation and other leading U.S. aerospace manufacturers are suffering the effects of declining aircraft travel, which in turn lead to revenue and liquidity challenges among second and third tier suppliers, many of which may end in bankruptcy.
Commercial aviation will continue to focus on liquidity and business survival and consequently analysts expect deal activity in the upcoming quarter to be at greatly reduced levels. With more positive budget outlooks and a geopolitical environment demanding defense spending, defense-related M&A activity has the more promising outlook among the broader aerospace sector.
Chemical M&A activity has largely been put on hold through the first half of 2020, although analysts expect chemical deal activity to return more quickly than the economy overall.
The sector is facing two-pronged disruption with the COVID-19 pandemic and the significant volatility and decline in oil prices. COVID-19 related safety of the workforce has impacted productivity and operational efficiencies. Oil prices have given temporary margin relief; however, product prices have been adversely affected.
On the positive side, chemicals are involved in efforts to fight COVID-19, including personal protective equipment materials, disinfectants, and plastics used in medical equipment.
While current challenges are largely unprecedented, companies have the opportunity to strategically evaluate their portfolios and position themselves for strong growth after recovery. Chemical M&A deal activity in the future is expected to be driven by consolidation strategies, growth through recovery and mitigation of exposed risk factors.
Construction and Engineering
With nearly half of U.S. construction workers furloughed through COVID-19 and municipalities facing budgetary cuts and delaying infrastructure projects, many are calling on the US government to invest in infrastructure.
The National Association of Home Builders/Wells Fargo Housing Market Index saw its largest monthly increase ever moving up to 58 points in June. Readings above 50 points indicates improving confidence.
M&A activity had stalled in the second quarter but is anticipated to recover later in the year. The construction industry has been slow to innovate digitally in the past; however, construction tech startups are seeing opportunities to demonstrate current capabilities, such as remote inspection tools and 3D scanning, which could revolutionize the industry. Tech innovation and improved digital capabilities also present acquisition target opportunities.
Oil and gas bankruptcies increased in the first half of the year due to the combination of supply and demand shock; Oklahoma’s Chesapeake Energy and most recently Chaparral Energy among them. Energy analysts expect many more companies to file for bankruptcy in the coming year if prices remain at low levels, particularly in the upstream segment.
Analysts consider Midstream a value-adding segment, yet note the regulatory uncertainty brought on by the upcoming presidential election, which could prompt divestitures among midstream companies.
Downstream and Oilfield Services segments are particularly hard hit with the dive in oil prices and the lower demand for refined products.
Even in the current environment, analysts see opportunities for M&A activity in divestitures of non-core and distressed assets, technologically advanced supply chain transformation, and industry competition.
As the industry deals with the ramifications of the pandemic, resiliency could be found in M&A deals to balance growth and cost containment. Analysts are looking to three factors likely to affect future M&A activity: i) liquidity of health services companies that have suffered revenue declines; ii) short and long-term opportunities created by the pandemic; and iii) pre-existing market variables, such as ongoing regulatory changes, competitive pressures, and consumer demand changes.
Technological advances continue to disrupt and advance the industry. Some examples include virtual clinical trials, augmented reality for staff equipment training, and virtual/home health. Needs have also increased for behavioral health and Medicaid, presenting growth opportunities for health services companies.
Long Term Care continues as a leader in deal volume. Deal activity did slow down as anticipated, but two sub-sectors grew year over year: Labs, MRI, & Dialysis and Other Services (which includes medical office buildings, out-patient facilities, physician staffing services, and pharmacy-related services).
Analysts expect industrial manufacturing to begin recovery during the second half of 2020, with more normalized levels of M&A activity in early 2021. This recovery will be sparked by efforts toward efficiency, supply chain risk management, and the necessity of technological innovation.
While still facing declines compared to the first half of 2019, Industrial Machinery led the sector in deal value and volume. Electronic and electrical equipment led transaction value for Q2 2020.
Many factories are reopening or hiring back some staff, although as of June, the industrial production index (IPI) was still 10.9% below pre-pandemic levels.
Transportation and Logistics
While the pandemic has impacted Transportation and Logistics through travel restrictions, operational and supply chain disruption, lockdowns, and declining oil demand, average M&A deal size in H1 2020 grew by 9% over H1 2019.
Trends of technology, innovation, and consolidation are expected to continue to drive deal activity. Companies with challenged balance sheets will continue to look at divestitures to free up cash, reduce debt service and focus on recovery and growth in their core business.
The Shipping sub-sector is expected to see continued consolidation to right-size the overcapacity it has been experiencing. Logistics will continue to evolve to meet increasing e-commerce, warehousing, and last mile delivery service demands.
How Can ClearRidge Help You Sell Your Business?
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ClearRidge is the leading M&A advisory firm in our region, closing more transactions than any other firm and recognized for the quality of our work and success at managing and arranging transactions for our clients’ companies. For further information on our team, industry expertise and transactions history, please visit www.ClearRidgeCapital.com.
Sources: This report has been compiled from reports and research including federal data, independent analysis, Reuters, Janes Capital Partners, Kiplinger, PCE-Companies, Mergermarket, PricewaterhouseCoopers, and SDR Ventures.