COVID-19: What are the impacts on merger and acquisition activity?
As confirmed cases of COVID-19 continue to escalate around the world, so too does the economic impact. Worldwide, we have seen the rapid developments in the disease cause a significant decline on global share markets and businesses of all different sizes being forced to shut their doors, contributing to a rising unemployment rate. These impacts have been felt far and wide, with the federal government stepping in with sizeable stimulus packages to save jobs and boost the economy. But what does all this mean for merger and acquisition (M&A) activity? The following are some of the observations we have seen so far in the market and what we anticipate how things may evolve.
Since COVID-19 was first publicised through various media outlets, deal activity has dropped. Marsh estimates that 25% to 30% of live deals in the Pacific region have been shelved as a result of COVID-19 concerns. Importantly, a key observation for these deals is that any valuation gaps between sellers and buyers have been exacerbated by the continued uncertainty associated with COVID-19, especially when parties consider short term versus long term outlook for the target business. Despite this, we have identified that many active deals are progressing well and the parties continue to have enthusiasm to transact.
In fact, Marsh anticipates that there will be an increase in deal activity from opportunistic buyers. A key example is distressed asset investors, such as specialised investment funds, who will be actively assessing opportunities to buy low-valued equity or debt packages. In this regard, businesses in certain industries, such as the travel and leisure sectors, which are under great financial stress, are likely to be susceptible. We believe that even traditional investors may seek to undertake transactions involving distressed assets when the opportunity presents and there is clear strategic fit.
Risk mangement concerns
It has become clear that financial investors are increasingly concerned with risk management. We expect this to result in more robust diligence efforts in an M&A context, especially regarding financial and tax warranties as breaches in these areas often represent significant financial exposure. Warranty and Indemnity (W&I) and specific tax insurance solutions are being used as strategic risk management tools to cover investors and their portfolio companies. However, it is also likely that W&I insurers may request a new exclusion related to business interruption or bodily damage caused by COVID-19, and this may need to be considered going forward.
In addition, we have observed that portfolio companies are looking to shore up their own operational efficiencies, reduce costs, and safeguard against any additional financial uncertainties to the extent possible. Ensuring adequate insurance coverage across the business, such as mitigating potential exposures from operational tax risks, is more important now than it has ever been.
For transactions that have been signed, material adverse change (MAC) clauses have already been triggered and we expect this trend to continue. Related to this, W&I insurers are increasingly wary of offering coverage for new breaches (warranty breaches that occur and are discovered between signing and completion). New breach coverage typically contains an exclusion related to matters which would constitute a MAC, but insurers are nevertheless not as willing to offer this coverage enhancement in the current environment.
Tax insurance implications
For coverage of specific tax risks either in an M&A transaction or outside the deal process, it is not expected that access to insurance markets will be adversely affected by COVID-19, or that any material changes will be made to policy terms. This is largely due to the bespoke nature of tax insurance policies, and because the risk profile for insured tax liabilities is not likely to be any higher as a consequence of the current environment.
Businesses under financial strain
Moreover, the uncertainty in the economy is already causing debt capital markets to become more stringent. We expect this will result in the deferral of highly leveraged buyouts and, more broadly, will impact the liquidity of businesses that are already under financial strain.
Lastly, it is evident that COVID-19 has had a profound impact on employees. As a result of the pandemic, it is important that employee retention, including that of key management personnel, is properly considered when undertaking due diligence in a transaction, as a deficiency in in-house capability of an acquired business can significantly impact operations going forward.
COVID-19 has had far-reaching impacts beyond those that are regularly discussed. As the virus worsens around the world, it is expected that the impact the disease has on M&A activity will continue to evolve over some time. Our expert team has been closely monitoring the trends around the world and are available to advise clients on the steps that can be taken during this time of uncertainty. In this context, tax insurance is one of the ways we can help businesses achieve greater financial certainty with respect to potential tax exposures. You can learn more about tax insurance coverage here.
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This article and any recommendations, analysis, or advice provided by Marsh (collectively, the ‘Marsh Analysis’) are not intended to be taken as advice regarding any individual situation and should not be relied upon as such. Any statements concerning actuarial, tax, accounting, or legal matters are based solely on our experience as insurance brokers and risk consultants and are not to be relied upon as actuarial, accounting, tax, or legal advice, for which you should consult your own professional advisors. Any modelling, analytics, or projections are subject to inherent uncertainty, and the Marsh Analysis could be materially affected if any underlying assumptions, conditions, information, or factors are inaccurate or incomplete or should change. The information contained herein is based on sources we believe reliable, but we make no representation or warranty as to its accuracy. Except as may be set forth in an agreement between you and Marsh, Marsh shall have no obligation to update the Marsh Analysis and shall have no liability to you or any other party with regard to the Marsh Analysis or to any services provided by a third party to you or Marsh. Marsh makes no representation or warranty concerning the application of policy wordings or the financial condition or solvency of insurers or re-insurers. Marsh makes no assurances regarding the availability, cost, or terms of insurance coverage. LCPA 20/094