01 May 2020

UK M&A Outlook for 2020

COVID-19 has caused significant disruptions to the UK M&A market.

In this article, we examine the impact on the M&A markets so far, outline some likely trends, and provide our top tips for future M&A deals.

What we’ve seen in the UK M&A market so far

  • In January and February 2020, we saw a push to complete many long-running M&A deals – usually supported by both buyer and seller with some larger PE backed deals announced

  • Stronger sectors that showed more activity were technology, business services, financial services, renewable energy, consumer and healthcare and there is likely to be more interest in e-commerce related businesses, telecoms, data, pharma, select retail and delivery businesses going forward

  • In March and April, we saw an increase in transactions between existing shareholders of a company, but few transactions between previously-unrelated parties. The focus now seems to be on strengthening the balance sheet and shareholder support

  • Several significant M&A transactions have been cancelled or indefinitely deferred although we expect there remains an imperative for divestment as the markets stabilise and plenty of dry powder around

  • Overall, M&A deal volume has substantially declined this quarter with the hardest hit sectors including leisure and hospitality, travel, offline retail and recruitment although these could benefit from any “bounce” post the crisis 

  • Due diligence has become more costly, lengthy and difficult in M&A deals as:

  1. physical due diligence and face-to-face management interviews are limited while travel bans persist

  2. assessing the full impact of COVID-19 on a target company requires enormous efforts and management time

  3. material adverse change (MAC), force majeure and frustration clauses in key contracts demand greater scrutiny

  4. historical supplier or customer arrangements may have been disrupted as a consequence of events and diligence of supply chains and their terms will be more important

  • With the UK Courts closed or substantially impaired, some transactions have been significantly delayed and/or unable to complete (i.e. restructurings via schemes of arrangement and capital reductions that require court approval) – court-free alternatives (such as contractual takeovers) should now be reconsidered

What we expect to see in the UK M&A market

  • Cash-rich investors such as larger PE funds, SWF and strong corporates are already looking for bargains – both sound (but undervalued) companies and distressed assets – especially if they are transacting with currency that has increased in value versus Sterling in recent months

  • Buyers are likely to first emerge from the regions that conquer COVID-19 earliest, potentially those from the Asia Pacific region, but those looking to acquire offshore assets are likely to face increased foreign investment approval scrutiny in certain sectors (and delays in receiving relevant approvals) 

  • Savvy PE, distressed asset managers and other institutional investors who are used to completing complex deals remotely will be among the early wave of buyers – provided they are comfortable completing deals with internal/fund level financing that could be refinanced with external debt at a later stage

  • Sellers will place even greater emphasis on deal execution and ensuring certainty of buyers’ funding – buyers should be ready to ‘prove’ their financial capabilities in future M&A transactions, especially as acquisition financing becomes more difficult or expensive to obtain

  • Negotiation of the allocation of risks between buyer and seller will become more complex – we expect an increased focus on warranties and limitations/caps, MAC clauses and force majeure provisions – while insurers will likely include blanket exclusions for COVID-19 impacts in W&I policies – meaning greater diligence will be required to assess and allocate associated risks

  • Buyers will likely demand increased (and exotic) conditions precedent (CPs), including:

  1. a “normalisation” CP – where the target’s business must return to “normal” before the deal proceeds

  2. a key man CP – that certain key employees remain employed by the target and unaffected by COVID-19 

  • Buyers will seek significantly greater information and control rights in the period between completion and signing, while pushing for shorter periods to satisfy CPs (although there may be a need for lengthier periods for certain CPs and approvals) – deal teams should prepare to apply for approvals immediately after signing

  • Sellers are likely to attempt to make broad disclosures against warranties for COVID-19 impacts – buyers should be alive to this prospect and consider whether such issues have indeed been ‘fairly disclosed’

  • Valuations will become more difficult – traditional methods based on earnings or cash flow may struggle to accurately price targets that have suffered significant COVID-19 impacts

  • Sellers will look for full payments in cash at completion, but buyers will want purchase prices linked to company performance with earn-outs or deferred consideration based on milestones being achieved as well as complex post-completion adjustment mechanics to account for COVID-19 uncertainty (the seller-friendly locked-box mechanic is likely to drift out of favour in a buyer’s market)

  • Parties will face increased regulatory scrutiny, and be required to seek additional approvals (and in particular, foreign investment approvals under the Enterprise Act or potential new legislation following the National Security and Investment Bill published in December 2019), while the predictability of such approvals will decline

  • Parties will encounter deal logistics issues, including:

  1. travel for site meetings, management presentations and deal negotiations or even for signing or completing is not possible for as long as travel bans and social distancing persist

  2. longer waits for regulatory approvals (and in some cases, expiry of approvals already received)

  • Share buybacks may start to be popular as listed companies take advantage of low share prices – although many companies with dwindling cash reserves have initially pulled out of share buybacks and forward-looking solvency statements from directors (who will understandably be reticent to make such projections) will be challenging 

  • Directors will be more concerned than ever with satisfying their UK directors’ duties and mindful of their obligations to creditors under the Insolvency Act if their companies are in distress and participating insolvent transactionsUnsolicited takeover offers may increase (for listed and private companies), as will shareholder activism (for listed companies)

Our top tips

  • As UK M&A transactions will take longer than usual to negotiate and complete, sellers should start preparing now to ‘hit the ground running’ when buyers emerge, including by: 

  1. establishing and populating virtual data rooms 

  2. considering instructing initial vendor diligence reports and investor memoranda

  3. formulating deal teams and reporting lines for fast and effective communication

  4. considering how to value the relevant companies (and preparing evidence to support the valuation)

  5. undertaking any pre-deal restructuring work

  6. appointing advisors to undertake preliminary deal structuring work – and critically, to determine which approvals will be required and how to quickly receive them (and whether any ‘new’ foreign investment approvals will now be required, and the impact this will have on the buyer universe)

  7. taking advice on UK directors’ duties and their obligations in a distressed landscape

  • Intending purchasers should start considering: 

  1. the critical issue of how they will fund acquisitions since sellers will demand certainty of funding 

  2. credible deal execution capability, including appointing external financial advisers and counsel where relevant

  3. when and where to seek external financing – experience with the 2008 GFC shows that public companies that raised additional equity capital earlier in the crisis did so at a smaller discount compared to companies who waited – similarly, the longer that downturn persisted, the more difficult it was to raise debt. In this market there may be only a limited pool of institutional capital but more alternative credit providers and PE funds willing to lend

  4. how a different debt to equity mix will impact post-returns on new investments

  5. whether it is worthwhile to buy FX now (or enter into deal-contingent FX swaps / forwards to lock in favourable FX rates) in anticipation of future transactions

  6. how they will respond to “sell-side” due diligence into the buyer, clarifying any approvals they may require and its financing undertaken by the seller

  7. whether additional foreign investment approvals are now required

  • Management of companies who expect unsolicited takeover offers should prepare takeover defences (assuming the shareholders would be hostile) or prepare for the sale process (if the shareholders are supportive)

This article was written by Barri Mendelsohn, King & Wood Mallesons London Corporate Partner, in collaboration with King & Wood Mallesons Corporate Partner Neil Carabine and Associate Ike Kutlaca in Hong Kong SAR.

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