MIT Sloan CFO Summit Summaries: M&A In A Downturn
Recently, I attended the MIT Sloan Business School CFO Summit. It was a virtual summit spanning two days with a star studded speaker list. I took extensive notes during the event and thought some of them would be of interest to the readers of this blog. One of the sessions was a panel discussion of Mergers & Acquisitions in a Downturn. The panel consisted of:
Dev Patel - (Moderator) - Partner at McKinsey & Company
Catriona Fallon - Chief Financial Officer and Chief Administrative Officer of Hitachi Vantara
Prashanth Mahendra-Rajah -Senior Vice President, Finance and Chief Financial Officer of Analog Devices
Tom Pizzuti - Partner at KPMG's Deal Advisory & Strategy Practice
Marc Montagner - Chief Financial Officer Endurance International Group
Below is a brief summary of my notes from the presentation. Because it was a panel discussion, some of the view points are slightly conflicting.
As CFO in a downturn number one priority is maintain liquidity. You never know how long the capital market can be shutdown in a downturn. Keep in mind, in downturn more people are coming to the capital market because they need liquidity, they need to raise capital, so if you are looking to acquire companies, you can often get companies for pennies on the dollar. As long as you have liquidity. That is key to survive. If you do and have some liquidity to spare, it is a good time to put out feelers to acquire people.
There will be swings in valuations when capital markets are disrupted. Be very patient when everyone is jumping in looking to buy. There is always a feeding frenzy and opportunity usually presents itself afterwards in the downturn.
Important thing to look for in M&A is what are the synergies and can we achieve them.
The market for deals started picking up in March and it is still picking up. The pace and volume of deals in October is like one panelist has never seen before. It has picked up with a vengeance. All their peers are in the same boat.
Overall it is a crazy time right now. One could argue in M&A doesn’t feel like a downturn.
There was a lull in the spring in M&A but it is back now, 2021 is set up for an even larger year in M&A. For Sept 2020 vs. 2019 global deal amounts very close to same. Semiconductor companies are hot right now.
This down turn is interesting, competitive advantage has become even more important than before. There are always synergies and financial gains in any transactions, but right now competitive advantage is critical. We've brought 6 years of advancement forward in a period of about 6 months due to Coronavirus. Everyone is doing more digitally. This is creating unique phenomenon.
Conviction and confidence is back. Some M&A enablers were in place and better set up for 2021 than before
Interest rates are low
Tax rates still low
Regulatory environment has been good so far. This might change with elections.
Uncertainty has come down compared to when the Coronavirus first appeared
Take these things together and people are shopping for cheap assets. Also, many deals that were scuttled on valuation, but came back and then revalued, received similar valuations. For example, Tiffany's was only down 3% . There hasn’t been a fall off in valuations. There was a real estate deal done recently that was only at a 10-15% discount compared to pre-Covid valuation.
Moderator Question: How do you value a deal in pandemic?
Prashanth Mahendra-Rajah said they struggled with valuation because when began, stock market was in freefall. Seller was concerned about selling at the bottom. The buyer was concerned that since they do not know how far it is going to fall, could they over pay. These conflicting concerns led one panelist to do an all stock transaction for an acquisition. There hadn’t been many in Tech that far. When he suggested this, he got a lot of pushback. However, recently many semiconductor deals have been all stock or heavy on stock. AMD and Xilinx, and Arm and Nvidia, heavy stock deals. It has become a bit more of the norm now. In July it was a headscratcher for investment community. It was the best way to hedge volatility in the stock market.
Catriona Fallon said that at Hitachi, which is a Japanese company they can't use stock in the US. They have to use cash, and they are competing against other acquisitions. The firm only has so much cash and can only make a select number of acquisitions. When evaluating a deal this past summer, they had to consider where is the growth going to come from, will this acquisition provide a global growth platform, and does it rise above other acquisitions the company is considering? What sets it apart? If they could have used stock, it would have let them go a little higher on the offering prices.
Tom Pizzuti said the movement in market has been incredible. Valuations have not stayed as reasonable as we thought. Healthcare or TMT (Technology, Media, Telecommunications) valuations, it is a frenzy. It is like a decade is happening in 7 months. He's not sure how to compare this to anything. He agrees that the factors laid out do sound favorable to M&A. The way this has swung and with 2nd pandemic wave building, makes you wonder what 2021 will be like. Most folks he deals with are more cautious - all finance folks. He is still wondering what 21 will do . The market is literally a frenzy. He thinks it can only be attributed to the 3 month hiatus in spring and people thinking tax laws will change under the new President Biden administration.
Prashanth Mahendra-Rajah added one more thing, we are coming out of decade long bull market. Many buyers think a correction is coming, They are thinking, " I know my strategic landscape, I know what is of interest to me, Let's wait for opportunities. Let's look for some kind of correction because this can't keep going." Then Covid hit and everyone went into lockdown thinking how they can do deals when can't get socially together. Deals have always been very social, but now you can't do that. When it became clear have to do via Zoom it opened up the venue to say, lets try to get activity going. As deals started filtering through, people got more confident They saw there was a disruption and said, "we need to strike now". The scarcity mentality has set in, (especially in semiconductors). It's move now or there will be nothing left on the board for you.
Moderator Question: Valuation Premiums in this down turns vs. others. In past saw opportunities to go bottom fishing, how is this different.
Marc Montagner felt that this is different than past crisis. 2001-2002 capital market was shut down. High yield market was shut down for long time. That was really the fuel for TMT world. People were borrowing heavily in high yield market and using it to grow, and when that shut down, TMT still needed money to grow. Demand stopped on buying equipment, this hit manufacturing in turn. Financial crisis cause drop in demand which created a buying opportunity. He was able to acquire substantial PPE (property plant and equipment) acquired for pennies on dollar. 2007-8 same thing. It was a financial crisis where companies did not have access to capital markets.
Different now, the Fed and Federal government and states giving more unemployment money. Saving rates among Americans today are the highest ever. Have pent up demand. Next year, if get the vaccine out, all demand for travel, restaurants, going back to malls, etc. will come back.
Look at Simon Property buying Taubman mall for only a 20% discount even though mall valuations down 70-80% in last 6 months because no one is going to the malls right now. Not really a financial crisis, its a pandemic.
Agree there was a complete panic in March & April, that is when they became active. Saw a lot of start-up companies funded by VCs that suddenly had a funding issue and needed to raise capital. They tried to move fast because they knew demand for online was not going away. Used opportunity to fill up their portfolio of products. They moved fast, but the window is gone now to do deal at a discount.
High yield market and equity market are wide open. As long as no liquidity issues, people will keep doing deals and it will keep going.
Moderator Question: As everyone look at various targets, how did you approach the process. How due diligence, how wine & dine? Will be in this environment for a few months even with vaccine.
Tom said they've done 100s of due diligence projects for clients over the last few months and haven’t traveled for any of them. The clients have rarely traveled. Maybe at the top of the organization meeting top of the sell side organization, but no bankers, no advisors. Only the most essential people are traveling. Working on integration is all virtual. When travel is needed is when factories are involved. Consultants who work on shop floor and have to integrate factories and improve efficiencies have to travel there, but otherwise very little travel, everything is via Zoom.
15-20 years ago it was big conference rooms at lawyer office with files and files. Then went to electronic data rooms. Now it is electronic data rooms in Zoom. None of the people in the deal market are leaving homes now, but deals still moving forward with fury.
Catriona agreed and said they had a difficult time with it. Even though comfortable on Zoom. It was more formal. There was a management presentation, not as many questions, not as much back and forth. There was not the opportunity to talk in hallway or have dinner. It was harder to get to know one another. Harder to know if there will be cultural synergies. Onboarding of a new executive team or new business is just difficult. Getting people laptops, water cooler conversations, etc. have been harder. We will see if that has impact on ability to be successful. They are doing Zoom happy hours, making effort to have that culture, but concerned about what happens to culture going forward with how remote things have gotten. What will this do to our children? They are learning remote, having remote relationships. Is this making them much more remote in business in the next 10-20 years?
Prashanth's experience was each step of process was a first to do virtually, and each step they didn’t believe would work virtually. He experienced building a relationship over Zoom during an acquisition and it worked well. Running diligence completely virtually they were wondering, can this be done? With right partners on both sides and dumping everything into the portal it actually moves much faster because there are no travel times. Getting board of directors on both sides aligned without being able to physically get together concerned them, but that worked too. Every step of the way they worried, "this really can't work" and then it did work.
Now his anxiety is how will we drive synergies and identify the parts of the acquired companies that are deeply important to us and have strong personal chemistry with them. Where there is redundancy, how will we determine how to best drive efficiency even with redundancy. These are social things, and how do you do it in a digital world. Today feels like might not work. He is nervous but he's been proving wrong on this concern every time so far, so it may well work.
This entire M&A deal (largest in semiconductor industry in the last few years), done completely remotely. Huge deal. Now completely doing the integration remotely. They had one physical meeting at a manufacturing facility just to walk the flor.
Tom said they are seeing this in other deals across country. Only seeing physical visits for the plants.
Moderator Question: What are best practices for M&A in the remote world
Marc felt overall it works well. It's more efficient, no travel. You can also bring in more people. He had some calls 35-50 people. Can get more junior people in there who are deep into the details to bring their perspective. Can do a deep dive much more easily because you have access to more resources on a video call than you would have in a conference room.
In past, it was always difficult to arrange board meeting. They were always very busy. Now with no one traveling and everyone at home, they could have meetings at 7am or 7pm. You knew no one was on a flight or anything. It was so much more efficient. The proof is in the pudding. Deals can get done. Especially with a technology company, no plant and no one is in office.
Prashanth added that confidentiality is so much easier in this new environment. Don’t have to concoct stories on why six management team members are disappearing for days at a time. In old model had to convene at an office and had to make stories up for their teams at the office to hide these trips.
Moderator Question: Moving forward how do you see M&A environment
Marc felt that as long as the capital market is open, will see more M&A. In tech industry it is all about filling up your product portfolio and suite of services. They spend about 10-15% of revenue on engineering & development, but very important to be active on M&A front to stay at fore front of innovation. If M&A can create value and markets are open will continue seeing M&A. Lot of debt in system, both corporate and government. As long as interest rates remain low, debt burdens are easy to carry. Future of M&A will be highly dependent on capital market.
Catriona agreed strongly. Pandemic has accelerated transition to digital and to cloud. This opens up all kinds of innovation and security needs. On security front especially, there are many small companies who can move quicker with innovation. She continues to see opportunities around small companies who can take the risk to invest in security around cloud, around IoT vs. large companies who aren't able to prioritize those investments because the revenue stream is not supporting those investments. In next 18 months likely see continued acceleration as larger technology players move more quickly to catch up in cloud and digital infrastructure.
Moderator Question: How do regulations and tax play into this
Tom wanted to add one more thing about future. M&A has become more and more efficient each year. Seeing billions into PE to move companies private that were public. No question it is more efficient. One area where could be much more efficient is when corporations look at portfolio and look at divestitures. That process is still a very difficult process for divestiture. Needs to be made more efficient. There should be an opportunity to apply the recent learning in M&A to this. As long as cap markets are stable M&A process should continue.
Regarding regulations and tax – people do not want to see taxes change again. It is too disruptive. It hurts predictability. People who fear that. The people who fear that right now and are doing deals are most founder, owner, operators. Those are the people who really loathe taxes and capital gains and want deals done now. Corporations have a more global and long term view on this. Taxes need to be stable and not move which would reduce unpredictability, so corporations can plan and execute what need to do. Hopefully enough counter pressure to keep taxes as they are.
Prashanth thinks there has probably never been as interesting a time to think about regulatory. specially for Technology companies. He thinks about it across four diff geographies: China, Europe, Britain and the US.
China you have 5 to 6 semi conductor deals all in the pipeline for them to approve at a time when semiconductors are being weaponized as an instrument of trade between US & China,
Europe, from a technology standpoint, are cognizant that they have allowed some of the Silicon Valley social network companies to get so large that European ones can't get foothold in there. They may resort to regulations or limit approvals of deals in future to allow European companies to get a foothold,
DOJ in the US. We heard in the Democratic primaries lot of noise against corporate consolidation. It was viewed as not good for US economy. Now that the Democrats likely to win, we have to see if that comes to bear and what it means for FTC & DOJ,
Lastly, with Brexit, London is looking for how do they make themselves have a voice in boardroom. When you think about regulator you think about the big three: Beijing, Brussels, and D.C. London is going to try to be a 4th voice. Curious to see how they to try to exert a perspective there. A well respected Professor at Cambridge already started talking already about how to set this up to protect London's tech infrastructure. Will be interesting to see this play out in next 12 - 18 months.
Marc reminded everyone that the feeding frenzy will end at some point. It will end when the capital market shuts down, and it will eventually. Could be from Inflation, tax increases, lack of stimulus, etc. It always comes from a shock from outside. We do not know when it will happen, but it always does happen.
Tom mentioned another thing to think about in the next 5-10 years is China. A lot more deals coming China and Europe and China and the US. Lots of pent up demand between US & China. We have to see what the new administration does with this. China wants to buy assets in US, Sooner or later it will go the other way too.
Audience question: Digital Due Diligence – harder to "kick the tires" on businesses from the culture side. How are you tracking and have you put new metrics in place so you get warning signs during digital due diligence from a culture perspective? Anything else you are putting in to get warnings? How are you weighing pre-pandemic vs. during pandemic results when looking at these metrics
Tom: Tough question, good audience. To answer the integration one: integration is really where culture comes in. What he has been hearing from his colleagues who support integration is that with the digital realm there is a lot more contact than used to be, even when used to plant someone at other company. More frequent touch points and ability to get to know each other. Not sure on metrics – he hasn’t on that heard yet.
Moderator: How are participants in M&A viewing the downturn? How are you taking account that the downturn has done a number on a lot of results, and how are you incorporating changes in metrics due to the pandemic when evaluating the success of a merger?
Tom said this question is more straight forward. Every company had a minor downturn during the spring. Some companies were 80-90% down if solely in hospitality/travel. Buyers have been carefully assessing how the company performed before lockdowns, and then how the cost structures were adjusted during the lock down, They then try to predict when and how things will recover (scenario planning). Most industries, except for hospitality and travel, are looking at Q4 2021 as when the real rebound happens. By 2022, most are assuming we will be getting back to 100% in most businesses, Then start 2023 with new growth. Not many buyers are considering or forecasting quicker paths. Certainly much longer paths with travel.
Prashanth said you have to answer two questions when it comes to valuation. Do you believe disruption is temporary, and if so adjust your model to when is it relieved, or is it permanent demand disruption? For example with the airlines, do you have conviction we will never return to business travel levels we had in the past due to the discovery of Zoom? If you do, and you believe travel will most be leisure and not business that will change your DCF (discounted cash flows) much differently than if you forecasted a temporary demand disruption. For companies like his that are suppliers to multi industries, the trade off is maybe there are a lot less miles flown, but there is more investment in wireline and wireless infrastructure to offset that. So they are confident they will grow, but mix will be different.
Marc chimed in to say that his firm is definitely seeing increased demand for their products since they are an online company and there has been such a large shift to online. He views this as an overall trend though, not a cyclical trend.
If had asked him 9 months ago if could do everything remote, he would have argued they would lose efficiency. Now though, there is no travel for work, not even a commute any more. Really astounded how efficient digital is compared to the old way. Honestly productivity has risen tremendously. He doesn’t see himself going on an airplane anymore. He might just do one trip to Asia and to Europe each year. Why waste the time flying? Everyone is now working with their colleagues on Zoom in other continents almost daily. Why waste a week every quarter flying international? In investment banking they are doing road shows virtually. No one wants to get in a plane anymore when not needed. The world has changed permanently. Why have large offices? Commercial office space is going to have to be redone.