April 5, 2020
Coronavirus – The Perfect Storm
By Jeremy Albelda
In these times of great uncertainty, we would like to give our clients some guidance as to what we see in the mergers & acquisitions and business brokerage market going forward.
Without stating the obvious, the arrival of the coronavirus, the oil price war between Saudi Arabia and Russia and an unprepared government in Washington DC – marketed by bipartisan bickering – produces the ingredients for the “perfect storm”. Every business is impacted, small or large, albeit in different ways. And whereas the crisis in 2008 was a purely financial crisis, the crisis today has multiple factors as causes.
At this point, it is highly doubtful that we will be able to avoid a recession. Unemployment numbers will shoot up, driven by layoffs and shut downs due to the coronavirus. Again, this will vary by region, with the hardest hit regions being the NYC metro area and California/Washington seeing the strongest impact.
More concerning is the fact in which we have warned our clients for quite some time: (i) monetary policy changes are limited by the already very low interest rates, whereas (ii) fiscal policy adaptions will generate even larger deficits after the ill-advised tax rate reduction at a time of full employment last year. In other words, the economic tools at the hand of the government are somewhat limited.
Savvy investors have been recognizing such, by way of a flight to “safety”. This trend not only manifests itself in a substantial liquidation in the stock market value, trending 30% lower, but also by an increase in the credit risk premiums for bonds. For example, the spread of bonds rated BBB – a $3.3 trillion S&P category called “investment grade” including companies like Boeing – widened to 3.68 percentage points, the same levels we have experienced when Lehman Brother filed for bankruptcy.
The concerns about credit risk is driven by a corporate credit bubble supporting “Zombie” companies that are held alive by all kinds of governmental bailout programs – the corporate bond market, the corporate paper market, banks, money markets, the US Treasury market, the MBS market, and the like. There is no question that the Fed – regardless of how much pressured by the Trump administration – will eventually have to roll back these programs, now larger than the first financial crisis which in return will lead to bankruptcies even among some large household name companies.
The unfortunate effect of the above mentioned is that many “safe” ETFs and municipal funds have BBB and BB rated bonds in their portfolio, resulting in a devaluation once the fed starts pulling back the tools to keep “Zombie” companies alive.
So, is there good news in this bleak picture and what do we learn from the last crisis?
As our firm leant in the 2008 crisis, there is tendency during uncertain times for buyers and investors to look for “safe” mid-sized companies. This is a preferable investment for buyers rather than placing funds into the uncertainties of the general stock market or bond market. During the height of the last crisis, our firm’s buyer inquiries were outnumbered by seller inquiries at a ratio of 5:1.
The unfortunate offset during that time, however, was that the Profit & Loss statements and cash flows of many mid-sized companies declined, and sellers were not willing to make a reasonable asking price adjustment – despite highly motivated buyers wanting to move forward. Additionally, new companies were not coming onto the market due to unreasonable seller expectations.
More importantly, the interest rate landscape in 2008 was characterized by very low rates, a particular strong impetus to deal making.
So, what did we learn from the last crisis?
In the end, many sellers motivated by unreasonable expectations and driven by their desire to “time the market” never closed a deal, only to find themselves many years later to sell at a price within +/-10% of what they could have obtained in 2008, while missing a time saturated with motivated buyers and low interest rates.
Fast forward twelve years, these very same owners now need to “live through” the same significant downturn. As a matter of fact, a third, if not half, of all business owners are in retirement age, recognizing at this time, how dangerous it is to keep “all eggs in one basket” by way of their net worth tied up in their private company holdings.
Nothing worse than attempting again now to “time the market” when every other business owner is rushing back with a sale into the market within a couple years from now, while at the same time the buyer market has dried up and interest rates went back up.
So, where do we go from here? A few observations we currently see:
- There is still an enormous amount of “cash on the sidelines” waiting to be invested
- Thousands of P/E groups and investors have raised “dry powder” and can’t simply return such funds back to their investors (or they would not be able to raise new funds in future)
- Buyer acquisition interest rates are again at historical low levels – with the banks lending
- The Fed is inserting additional cash into the economy, making even more funds available
- At this time, private buyer inquiries and interest with our firm continues to be very strong
- Healthy companies will use the cash for acquisitions, as we have seen already first inquiries
- With over 500,000 investment community contacts in our dedicated proprietary database, we can deliver targeted campaigns to most folks – quickly and efficiently by email will somewhat adjust the seller’s asking price, however, often this can be mitigated by a change in deal structure, i.e. deferred payments or earn outs
- Our firm has the technology in place to operate completely remote among our 20 offices nationwide, providing continued services and health safety to our clients and team members
- Our professionals have the experience to have worked through the last crisis and standby for our clients to provide needed advice
Whereas M&A activities will undoubtedly be slower in the next couple quarters, the smart, mid-sized company sellers will continue to sell their companies and take advantage of the current situation, recognizing that they might be selling at a minor discount or changed deal structures rather than attempting to “time “ the market at its peak (which they missed) – never mind the fact, that nobody can predict the next market peak in a recession marked environment in any case.
In the end, let’s keep in mind that the coronavirus is a temporary “bump in the road”.
Setting the human tragedy aside in this blog and the inconveniences we all have to share, the economic life will return to the “new normal” once the infection rate is (truly) under control, vaccination has been developed and national, fast testing is widely available. Once the risk of death from Covid-19 is mitigated via relatively safe treatments, market confidence should bounce back quickly.
Hopefully, private industry learnt in the interim to re-allocate capital in a less leveraged fashion and to secure sourcing with lesser dependency on single supply chains located abroad, and the administration will have implemented the proper precautions rather than to mislead its constituency with incorrect predictions.
What can our firm do for you?
If your business requires SBA (bridge) loans, we will gladly help you in facilitating an introduction with banks. With over 250 lenders a click away in our database, our professionals are well positioned to find the right match for you.
Furthermore, in recognizing the uncertainty of times, we will extend a special program to all clients requiring a new valuation until June 30, 2020 by providing a free valuation update for twelve months thereafter.
Remember, good businesses will still be sold and bought in this environment, and this might not appear as the best of times, but could certainly turn out exactly the be that, stay Covid-19 positive!
About A Neumann & Associates, LLC
A Neumann & Associates, LLC is a professional mergers & acquisitions and business brokerage firm having assisted business owners and buyers in the business valuation and business transfer process through its affiliations for the past 30 years. With an A+ Better Business Bureau rating, the company has senior trusted professionals with a deep knowledge based in multiple field offices along the East Coast and has performed hundreds of business valuations in its history. The firm’s competitive transaction fees are based on successfully completing transactions. For more information, please contact A Neumann & Associates at 732-872-6777 or firstname.lastname@example.org