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2021 M&A Outlook

Posted on January 6, 2021 By

The Beginning of the End

The turbulent year of 2020 is finally in our rearview mirror. While so many lives have been lost and everyday life is still far from normal, effective vaccines for COVID-19 are being distributed, offering hope for a near-term end to the disruption we’ve endured for the past year.

Markets have begun to respond with optimism for the highly anticipated return to normal, but we’re not at the finish line quite yet. Mass distribution of the vaccine will take time, and people and businesses are still suffering as the virus is spreading at record-high levels and restrictions are being reinforced. This means that, yes, our world remains suspended in a state of uncertainty, but we have good reason to believe that the global economy will continue to recover, and mergers and acquisitions will lead the recovery. Research indicates that 53 percent of US executives plan to increase M&A investment in 2021. Some sectors have fared rather well during the pandemic. But how well—and how quickly—the overall economy recovers will depend on factors such as virus containment, fiscal and monetary policy, and inflation.

Virus containment remains the main priority for economic recovery to succeed. However, there are other possible risks to market performance. A lack of adequate policy support could occur due to concerns about mounting government debt. The technology conflict between the US and China is likely to continue even under a more traditional Biden administration, and the impacts are expected to take years to manifest. The decisions made by the two countries will affect regional economies and the businesses that operate within them. Other geopolitical factors could also shift investor attention away from recovery, but they are considered rather unlikely at this time.

M&A Outlook

As 2021 is finally upon us, there is plenty of lingering uncertainty. We do expect to see more megadeals (of at least $5 billion), especially from pharmaceutical companies picking up products in trending therapeutic areas to drive consolidation under low interest rates. We also expect to see more private equity (PE) acquisitions. Company valuations will be increasing from their pandemic lows, with the larger company multiples leading the way. While companies may have the capital needed to make major buyouts, extracting real value will require creative thinking for bigger deals with higher valuations.

Megadeals soared in the second half of 2020 with this momentum carrying over into 2021. Corporate megadeals are being seen in several sectors. Most of these deals involve buyers and sellers within the same sector. This demonstrates efforts to scale up during a downturn.

About a third of US corporate transactions in 2020 were cross-sector deals. This is consistent with previous years. Many of these deals involved technology for improved efficiency and enhanced operations.

 Some corporations fell into distress during the pandemic and sold off companies or divisions to raise capital. More strategic divestitures are expected in 2021. By proactively reassessing their portfolios, these larger companies hope to create a better focus on core capabilities and pursue the best routes for growth. There may be arms of a business that make the most sense to sell. Divesting businesses that can succeed elsewhere could be a key driver of value creation under the right circumstances.

2020 and the pandemic redefined the importance of digital transformation as everyone was forced into living and working in an online world, and 5G technology is only beginning to be rolled out and is expected to greatly influence the future. The degree to which technology will transform production and consumption is massive. Companies that invest in technology and innovation during difficult times are likely to emerge stronger, whether it’s increased efficiencies or bringing new products or services that disrupt the market. Research shows that more than half of business owners said that tech investments made during the pandemic would make their companies better off in the long run. And nearly 80 percent of business owners said that their companies plan to increase investment in digital transformation in 2021.

Private equity is still sitting on a ton of capital, deal value is up, and firms are looking for opportunities in the healthcare and energy sectors in particular. The demand for healthcare innovation surged during the pandemic, but this demand has proven to be persistent and omnipresent. Laboratory testing has been and will continue to be in great demand, even beyond COVID-19. Also, 2020 was a major year for sustainable investing as the S&P Global Clean Energy Index was up nearly 100 percent. The sustainability trend is expected to skyrocket in coming years, especially in the food sector due to the significant and expensive problem of food and water waste involved in food production.

Special purpose acquisition companies (SPACs) surged from 2019 to 2020. SPACs go public solely to raise funds to acquire or merge with private companies. 2020 saw three times as many SPACs complete IPOs, with total capital raised being nearly five times higher. For some investors, it’s a way of supporting tech that may have more growth potential during the pandemic. Others see it as a path to raise capital in volatile markets and partner with blue-chip companies that have entrenched sector expertise.

Other business imperatives that are driving value creation in M&A include diversity in leadership and workforces, commitment to social justice, and more accountability among shareholders to their customers. More than ever, consumers are reporting that a company’s values play a major role in their purchasing decisions. This means that acquirers and target companies must focus heavily on staff, transparency, and other factors that will impact company valuations and potential returns on a deal.

Recovery has just begun, and it could last for years. While it’s good to have optimism, it is even better to have a solid, long-term strategy that makes sense for your goals. Plan with the big picture in mind, knowing that global healing is underway with some countries ahead of others. Companies should have a forward-looking view to help insulate them from policy changes that create tax or financial impacts that could thwart deal strategies.

Tracking the Global Recovery

The United States

America has done a poor job of containing the COVID-19 virus, but the policy response was effective. The $2.2 trillion CARES Act was passed in March, and it worked to limit the damage of the initial lockdown. Consumer rebound was rapid in the US, especially in some sectors such as housing. Both household and corporate cash balances are up and interest rates are down. Bankruptcy rates are lower than before the pandemic. Corporate debt default rates are also in decline. A second stimulus package worth around $900 billion has just arrived. It s includes boosts to weekly unemployment insurance payouts a new round of PPP loans (though more targeted than the first round) and is critical for workers and businesses that are still suffering. There are still areas of real damage to the US economy. More than 3 million workers in the leisure and hospitality sectors are no longer employed and permanent unemployment has increased. While the labor market sustains lasting damage, the US economic healing process is underway and the delivery of a vaccine points to a more positive road ahead.

The Federal Reserve entered the pandemic with latitude to lower policy rates and a financial crisis plan to repair issues in credit markets. The Fed shifted toward an average inflation-targeting framework, meaning it wants employment to reach maximum levels and inflation to average two percent. It set policy rates at zero and is buying $120 billion worth of Treasury bonds and mortgage-backed securities each month, and committed to not raising policy rates until employment and inflation targets are met, which could take years.

Europe

Europe also did a poor job of containing the virus. Spikes in cases resulted in new lockdowns that slowed the economic recovery’s momentum and the effects vary across different countries as the weaker economies rely heavily on tourism. The slow recovery of travel-dependent industries puts several European countries on the list of forecasted shrinking economies. The European Recovery Fund showed an exceptional level of political commitment to coordinated monetary policy, but at 750 billion euros, it is unlikely to restore pre-pandemic GDP levels in 2021.

Europe faces challenges in providing policy support, as interest rates already are negative and asset purchase programs near self-imposed limits. Because of the limitations of the European Central Bank (ECB), the European Union (EU) appears to be more dependent on fiscal support to create positive growth. Eurozone fiscal rules are currently suspended, and markets are tolerant of large deficits run by all countries, which is good. But even post-COVID, policymakers will face individual countries with widely differing economic performances and challenges that will pose a need for more policy support. There are countries with little or no growth and weak banking systems, which have kept their economies fragile for a while. Some economic progress has been made but the pandemic has caused real damage, especially to the hospitality and tourism industries. A vaccine will be crucial to recovery, as well as the timing of the funds from the EU recovery facility.

The United Kingdom has notable policy space, yet the government appears hesitant to use it. The Bank of England has prepared operational mechanisms for negative rates and will extend quantitative easing as needed. But the U.K. treasury seemed determined to yank support as soon as possible, then a second wave of the virus hit and it had to back off. Tightening of policy support will remain a key risk in the country and the last-minute emergence of what is being called a “new strain” of the virus right as the Christmas season started will certainly dampen Q4 2020 results adding further doubt to the UK’s 2021.

Asia

China and most of Eastern Asia were relatively successful at containing the virus, and the policy response has been adequate. China’s initial economic recovery was led by the industrial sector, aided by strong exports. It was also less dependent on fiscal policy because of the virus containment and, therefore, less need for additional support. Since then, the recovery has expanded to services and consumers. Travel and tourism are near normal, even with no vaccine. This recovery is on track to sustain itself as long as there is not another COVID-19 outbreak. It is possible that the country's budget deficit could be smaller as a share of its GDP in 2021 and the following years than it was in 2020.

Taiwan and South Korea also experienced a relatively early economic recovery, largely in part to a high global appetite for technology exports. Japan was already struggling with the recessive effects of domestic policies, lower demand due to tax increases, deflation, and hampered exports, and COVID-19 only made it worse. India, Indonesia, Malaysia, and the Philippines have each grappled with virus containment and economic growth. In these economies, recovery will depend largely on virus containment, vaccine availability, and whether the US dollar does not appreciate.

Latin America

The recovery in Latin America lags behind the rest of the world. Because of the region’s informal labor markets and poor public health systems, it was severely unprepared to deal with a pandemic. The virus spread rapidly through densely populated, poor areas and effective restrictions were put in place until authorities realized that it could result in economic disaster. Latin American banks aggressively slashed interest rates to unprecedented levels. But countries in the region only have so much fiscal policy room without the ability to borrow as liberally as countries such as China and the United States. To make matters worse, they already used what scarce fiscal power they had to protect their economies and reactivate growth. Economic growth will begin to slowly recover in 2021 but still faces risks such as Mexico's policy uncertainties and lack of stimulus, Brazil's withdrawal of fiscal relief and rising debt, and Argentina's economic imbalances and market-unfriendly policies. Under such damage, the Latin American region's economy will take years to recover.  

 

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The Promise of a Vaccine

Several pharmaceutical companies have developed an effective vaccine and steps are underway to distribute it, with some healthcare workers and high-risk populations already being vaccinated. But this isn’t a magical overnight solution. It will take time to vaccinate a meaningful amount of people, and many will not be vaccinated either due to personal choice, logistics or economic constraints.

It is likely that other ways to control the spread of the virus will still be required through 2021, such as mask compliance, testing, contact tracing, and certain restrictions. Improvements in treatments should evolve for treating those who are infected.

Even without mass vaccination, we have seen a global rebound in consumption and production activity. Consumer spending has shifted away from sectors such as hospitality and toward areas such as housing and e-commerce. Retail sales in the US are already at pre-pandemic levels. Inventory restocking has spurred a recovery in production and trade. Chinese production and exports have increased dramatically and American stay-at-home shoppers are driving the sales of Chinese-made goods. In November, China reported a record trade surplus of $75.43 billion. This was propelled by a 21.1 percent surge in exports compared with November 2019. Exports to the United States led this jump, which climbed to a record-setting 46.1 percent to $51.98 billion.

A vaccine does offer hope for the harder hit sectors that depend on in-person services, such as the leisure, hospitality and retail industries, which have lost millions of jobs. With a vaccine, consumers are more likely to start returning to pre-pandemic normal activities such as dining out and traveling, simply because they feel safer doing so. But it is important to remember that a vaccine isn’t going to eliminate the threat of COVID-19 overnight, especially because millions of people will not be able to get it right away, pointing to a long path toward economic recovery.

The Possibility of Inflation

Inflation is key for investing because it is critical to central bank policy and interest rates and it also directly influences the purchasing power of cash. Inflation is expected to rise modestly in the United States, Europe and Japan to rates where it was for most of the previous cycle (around one to two percent), so policy rates should remain anchored, and investors should be cautious about holding surplus cash, and yield will be difficult to find. Investors may want to focus on U.S. high-yield bonds and preferred equities. Additionally, some assets do well when inflation is rising from low levels, such as real estate, infrastructure, and commodities. This could provide some investment opportunities.

Modestly rising inflation would make sense alongside improving global growth. Inflation expectations have already reached pre-pandemic levels in the US, but remain below the Fed's two percent target. In the Eurozone and Japan, expectations are still depressed. Central banks will need to stay supportive to keep inflation expectations near their targets.

The Strength of the Dollar

The value of the US dollar relative to other currencies can be indicative of relative growth, policy expectations, and broad beliefs about risk. The dollar is not expected to lose its status as the world's reserve currency. The US dollar could continue to weaken, but modestly from current levels. As the global recovery continues, investors could move capital outside the US into higher-return opportunities, which can drive up the value of the dollar.

As the global economy continues to heal, it makes a case for more modest dollar weakness relative to trading partners. If the dollar keeps weakening, it is a sign that global recovery is underway. Keep an eye on currency exposures and consider who could benefit from a weakened dollar, such as emerging market countries, and companies that earn revenue in local currency, but pay debt service in US dollars.

A Shift is Coming

The pandemic shined light on issues such as our reliance on global supply chains as well as cyber weaknesses. Now that these issues have been revealed, supply chains are likely to shift as lawmakers encourage more domestic production versus reliance on foreign sources. Some companies will be well positioned to benefit from such an adjustment.

Another lasting outcome of the pandemic is that it changed the way that M&A deals get done. Even though a vaccine is on the way, some elements of virtual deals are likely here to stay. Whether it’s due diligence or negotiations, embrace the process, and how it could improve the chances of deal success.

Risks to Global Recovery

While recovery is underway, there are certain factors that could throw an economic bounce-back off track.

The US-China Trade War

The relationship between the two countries has been rocky. The signing of the 2019 Phase One trade deal can have major impacts on the tech sector, which is the largest of the global equity market. The US is concerned about protecting intellectual property and data privacy to maintain technological leadership. China is worried about having a significant part of its economy stifled by US export bans and agreed to buy more US farming goods. Both nations agreed to refrain from purposely manipulating their currencies. There have also been non-economic tensions between the two countries, with military territorial squabbles regarding the US Navy’s operations in the South China Sea. The incoming Biden administration is likely to take a more traditional approach to negotiations with China. This should boost the confidence of companies and investors.

Government Failure to Act

Creating more government debt in order to stimulate economies makes many lawmakers nervous. In the US and the UK, politicians have been fighting against racking up more debt and causing some negative market ripple effects. And high levels of debt could certainly affect future spending on areas such as infrastructure, law enforcement, and education. But until a vaccine is widely available, businesses and workers in highly impacted sectors will still need help. Proper fiscal support in the near term is going to be a pivotal factor for the global economic healing process. Fortunately, in most developed countries, the cost of servicing debt is low, and banks are helping to ensure that doesn’t change.

Other Geopolitical Factors

It is important to monitor how any potential conflict can impact financial markets and economies. Ongoing unrest in the Middle East has a tendency to affect the economy and financial markets via oil prices. Currently, Turkey poses a threat to Saudi Arabia, Russia and Iran, as it becomes a more major player in the region. Europe is also seeing its share of instability, as the UK is still going through Brexit, Scotland has been discussing withdrawal from Great Britain, and Italy has speculated about leaving the EU. Typically, these types of geopolitical disturbances elapse relatively quickly and the impacts can be alleviated through diversification that spans asset classes and regions. Planning well with goals in mind can have you prepared to deal with volatility that can affect your investments. Businesses with strong balance sheets and stable growth profiles can protect capital in volatile markets. Also, there are several megatrends that will be driving markets for the next several years: healthcare innovation, digital transformation, and sustainability.

  • The pandemic has forced us into highly digital lifestyles and accelerated the adaptation of telehealth services.
  • There is significant investment opportunity in medical testing and diagnostics. Advances made in COVID-testing technology and manufacturing will likely lead to other at-home testing capabilities.
  • Game-changing 5G technology is finally upon us and will open up more opportunities for growth in enterprise.
  • Manufacturing is forecast to account for 19 percent of 5G-enabled revenue opportunity by 2030.
  • The Biden administration is likely to support policies that promote clean energy and infrastructure.
  • Agriculture technology (AgTech) is being used to make food production more sustainable, and to improve traditional food production efficiency.
  • The vertical farming market is expected to increase almost 6x globally by 2026.

 About Benchmark International:

Benchmark International’s global offices provide business owners in the middle market and lower middle market with creative, value-maximizing solutions for growing and exiting their businesses. To date, Benchmark International has handled engagements in excess of $6B across various industries worldwide. With decades of global M&A experience, Benchmark International’s deal teams, working from offices across the world, have assisted hundreds of owners with achieving their personal objectives and ensuring the continued growth of their businesses.

Schedule A Call

 

Americas: Sam Smoot at +1 (813) 898 2350 / Smoot@BenchmarkIntl.com

Europe: Michael Lawrie at +44 (0) 161 359 4400 / Enquiries@BenchmarkIntl.com

Africa: Anthony McCardle at +27 21 300 2055 / McCardle@BenchmarkIntl.com 

ABOUT BENCHMARK INTERNATIONAL

Benchmark International’s global offices provide business owners in the middle market and lower middle market with creative, value-maximizing solutions for growing and exiting their businesses. To date, Benchmark International has handled engagements in excess of $6B across various industries worldwide. With decades of global M&A experience, Benchmark International’s deal teams, working from offices across the world, have assisted hundreds of owners with achieving their personal objectives and ensuring the continued growth of their businesses.

Website: http://www.benchmarkintl.com
Blog: http://blog.benchmarkcorporate.com

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