Pandemic brings slowdown and uncertainty for 2020; rebound coming into view
After another strong year of M&A activity in 2019, the first quarter of 2020 began in a similar fashion but ended with feelings of uncertainty, at best, and fear, at worst. Although the landscape has continued to evolve over the last two months, it is important to understand where things stood pre-COVID-19 and use these baselines to make informed decisions in the months ahead.
M&A deal activity
The COVID-19 coronavirus backdrop led to a sudden shift in the underlying macro dynamics influencing M&A activity in Q1. State-government-mandated economic shutdowns, rising unemployment, a plunging stock market, deteriorating financing conditions and increased expectations of a prolonged recession in 2020 all led to the beginning of an M&A correction. PitchBook reports that total deal value in Q1 2020 was $400.8 billion, down 25.1% year over year. And keep in mind that the first half of the quarter was not heavily impacted by COVID-19.
Middle-market valuations increased to 7.4x adjusted EBITDA, as reported by GF Data in its Q1 2020 M&A report. However, it is important to note that most of these transactions closed before the global pandemic was in full swing. It is expected that both deal activity and valuations will remain below Q1 levels over the next two quarters as a result of the pandemic.
Consistent with previous quarters, size continued to be a significant driver of valuation. Transactions in the $10-$25 million range averaged a 5.7x EBITDA multiple, and deals in the $100-$250 million range averaged a multiple of 9.6x.
Across all industries, distribution and technology received the highest valuation multiples at 8.9x and 8.7x, respectively. Four business categories — including manufacturing, business services, healthcare services and distribution — accounted for approximately 80% of GF Data's contributors deal volume in the first quarter of the year.
While total debt levels remained relatively flat, there has been a steady increase in average senior debt multiples from 3.0x in 2018 to 3.3x in 2019 to 3.5x in 2020. GF Data reports that standalone senior debt providers are extending themselves to compete with popular single tranche offerings.
Navigating the COVID-19 pandemic in 2020
We are currently operating in an environment quite different than what was seen in the first quarter. Despite the M&A slowdown and overall economic uncertainty, deals are still getting done. New deals are being launched on a selective basis, and many in-process deals continue to move forward, with careful consideration being given to timing, process design, deal structure and valuation expectations.
Wipfli Corporate Finance Advisors anticipates that valuations and deal activity will rebound towards the end of the summer, leading into fall. With that in mind, preparation for sale should begin now. Buyers will look through the financial impact of COVID-19 and will focus on the ability to rebound.
Additionally, buyers will become more aggressive, as there is too much capital needing to be invested for financial buyers to stay on the sidelines for very long. Markets will work towards an equilibrium, and a new “normal” will begin to emerge. WCF stands by, ready to help clients navigate this turbulence.