20 April 2021
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The world has lived through just more than a year of the COVID-19 pandemic. Much has changed in our daily lives: the people we interact with, in our homes, and in our consumption, work and recreational patterns. The M&A market is no different, and despite a sharp downturn during the initial stages of the pandemic, deal-making in Q1 2021 has made a spirited comeback. Sandra and Eef from our corporate / M&A team in Singapore present their views on why the M&A market has made a strong comeback and its implications for deal-making in 2021.
A likely explanation for strong deal-making activity is Sellers becoming more realistic about valuations. With the valuation gap closing over the course of the pandemic year 2020, many institutional funds and investors are putting to use money that had been sitting on the side-lines long before the pandemic due to lofty valuations of Sellers pre-COVID-19.
The pandemic also exposed and accelerated huge shifts in the global economy that have been underway over the past decade. Purpose-driven businesses, many under the banner of sustainability, have weathered the COVID-19 downturn well, as the societal value of business resonated with consumers who found themselves with more time to consider the impact of their purchasing choices. New economy businesses with disruptive technologies also outperformed the market as social distancing and travel bans meant many more turned to online solutions for work and play.
As a result, legacy businesses are urgently looking to make synergistic acquisitions in order to transform and safeguard their future. If a legacy business fails to transform by acquiring new technologies, business lines and data despite the current supremely cheap cost of capital, such a business will likely fall behind. Most businesses engage in M&A rather than R&D to quickly scale up to survive in the market.
From our desk in Singapore, home to many regional HQs for the Asia-Pacific region, and with the above big-picture trends in mind, we observe distinct trends emerging in M&A negotiations and legal documentation in Singapore and the South East Asian market.
1. More Variety of Consideration Structures
Overall, the M&A market is more Buyer friendly today than it has ever been over the past decade. Valuations are based on ascertainable enterprise value/EBITDA and carefully derived from detailed due diligence. Bid-ask spreads are also neck-to-neck and sometimes so close that other factors such as the laxity of the contract mark-ups come into play.
However, there is still significant perceived structural and economic risk in the market. For instance, there are questions as to whether the vaccines will be effective against new variants of the virus. The shape of the economic recovery once herd immunity is achieved is also unclear as it is uncertain whether pent-up demand will drive consumers to go on a buying spree or if demand will remain modest and subdued. Major questions remain about the viability of retaining office space or maintaining standard business services when the workforce inclines towards flexible working hours and mobile technology.
Due to the above uncertainties, Sellers are more receptive to consider earn-outs, escrow holdbacks and deferred consideration structures to get Buyers comfortable with latent risks in the market. Few Buyers will be willing to pay full consideration up-front in the current day economic environment.
2. More Buyer Warranties and Indemnities
Another distinct trend is Sellers being more accommodating of Buyer-led inclusion of a broad suite of warranties and indemnities in transaction agreements covering all aspects of the business, including data privacy, licensing regimes and employees. The level of detail in the warranties is no longer inversely proportionate to the level of due diligence conducted by Buyers.
Having said that, Buyers are still required to justify the degree of protection sought through warranties and indemnities with cogent arguments, such as gaps which cannot be met by due diligence. Although the market may be more Buyer friendly, there is also stronger competition amongst Buyers with financial muscle as more private equity and fund players come out to put dry power to use in a low interest rate environment where holding cash is more costly than investments. Therefore, a Sellers’ stance in the 2021 M&A market can be summarised as being more accommodating of Buyer requests but not necessarily desperate to sell to any particular Buyer.
We also notice a change where Sellers are clearly informed by Buyers in advance that the scope of due diligence will be limited as parties aim to push the deal through quickly. In some cases, the Seller may put up their own diligence report and offer a fixed suite of warranties. However, in the majority of the cases, the Seller will tolerate broader warranties to cover areas of risk where Buyers have not completed fulsome diligence.
3. More Conditions Precedent During Negotiations, Which May be Watered Down
In the midst of heavy deal-making activity, Buyers are inclined to rush to sign transaction documents, particularly to close off a competitive process and move on to the next transaction or attend to integration matters.
As a result, many elements of transactions are expressed to as “conditions precedent” to be achieved by Sellers between signing and closing; this may include shedding defunct business lines, intra-group restructuring, securing continuity of external funding, or obtaining regulatory approval as governments show no signs of letting up on market scrutiny despite the on-going pandemic.
In fact, in many ways regulatory scrutiny is heightened as governments around South East Asia and the world are even more aware of social inequality that has been exacerbated by the crisis and the perceived effects of changes arising from the new data-driven economy. Licences for regulated sectors, as well as work permits, talent visas and foreign worker quotas often stand out as the most challenging elements in closing.
A head-on clash on the conditions precedents sometimes leads to some tussle between Buyer and Seller on coming to an alignment on the sale & purchase agreement, but can also take the form of negotiations on a MAC (material adverse change) clause which would entitle the Buyer to walk away before closing. The incidence of Buyers locking in founders or management for a fixed term post-close is also rising, as security for business continuity and staving off competition in the market.
4. Unforeseen Risk Allocated to Buyers
Although we have expressed Sellers are more accommodating of Buyers to get deals through, Sellers are also enjoying the chance to cherry pick suitors as more potential Buyers hunt in the market for deals.
As such, Buyers are also increasingly asked to take on the risk of unforeseen events. It should be noted that the aforementioned MAC clauses are largely viewed as highly antagonistic and are considered to be dealbreakers for many Sellers. In fact, more Sellers are seriously considering including Hell or High-Water Clauses in the transaction documents. Such clauses require Buyers to complete the purchase, as the name suggests, come hell or high water. Somewhat surprisingly, Buyers are not totally unwilling to consider Hell or High-Water clauses in the present market, possibly in a show of give and take where Sellers accommodate broader warranties and tranche payment of the purchase price to cover off known or other forms of risks.
5. More Use of W&I Insurance
We are observing, following a rather dry spell in the past two or so years, a revival of interest in W&I (warranty and indemnity) insurance, as institutional shareholders seek to make clean exits from holdings in order to return funds to investors and as the level of warranties sought by Buyers intensify.
We are also observing greater sophistication in the transactional insurance market in Singapore, particularly new insurance products covering pollution and new breaches. Additional premiums are payable for such coverage but may make good commercial sense for certain types of Buyers.
6. Unclear Whether Distressed M&A Activity Will Pick Up
COVID-19 has caused some market distress, with a few more instances of insolvency and liquidations occurring than usual. However, widespread corporate bankruptcies have not arisen in the Asian market as yet, at least not involving relatively larger or more established corporations save for the recent headline case in the oil bunkering market. Smaller mom-and-pop enterprises and small community entrepreneurs are definitely suffering, but these businesses are rarely the target of M&A activity.
We have not observed a significant up-tick in distressed M&A, although re-organisations or restructuring may likely occur in vulnerable sectors that are comprised of large companies, for instance in retail, entertainment, travel, hotels and leisure.
It remains to be seen whether 2021 will present more distressed M&A activity.
Conclusion
M&A is clearly flourishing amidst the backdrop of an uncertain economic outlook, but deals are somewhat more Buyer friendly in 2021. Buyers largely flock to innovative, sustainable or tech-driven business as prices come down and are more aligned with Buyer assessment of enterprise value. Buyers are also finding more success in seeking detailed warranties and indemnities to mitigate risks and to deal with tight timelines for diligence.
On the other hand, Sellers have many potential suitors to choose from: it is a question of how much time, effort and costs they are willing to expend to extract the maximum price, benefits or synergies from a sale. A well-managed bidding structure always works to the Sellers’ advantage, so putting the business out to tender is becoming commonplace, and it’s a sure-fire way to lure strategic and corporate buyers, as well as purely financial buyers such as PE. Consequently, the current market is one where Sellers tend to be more focused in keeping the competitive process going for a little longer and leveraging the competitive dynamic to strategically negotiate for the best price with the most manageable risks. Sellers can also demand a clean exit by requiring W&I insurance or weave in post-close collaboration undertakings with the new owners to maximise their earn-outs.
Distressed M&A activities are subdued on account of corporate failures having hit smaller businesses that are below the market threshold for meaningful M&A.
For further information, please contact:
Sandra Seah, Partner, Bird & Bird
sandra.seah@twobirds.com
