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Let’s Make a Deal: COVID-19 to Spark M&A Surge This Year

Coronavirus disruption could spur a wave of mergers and acquisitions through the year’s end and beyond, as a struggling economy surfaces takeover prospects in the retail and supply-chain sectors and investors are motivated to spend.

While normal business activity is on pause, companies should take this opportunity to “reset and reposition to grow,” said Bahige El-Rayes, a partner in the consumer practice of global strategy and management consulting firm Kearney. Private-equity firms and strategic buyers alike are upbeat about M&A potential, he added, especially for prospects specialized in digital engagement—a necessary skill in a socially distant world. Retailers in particular are interested in elevating their customer experience and fostering strong digital capabilities.

“In all prior pandemics, there’s basically a shift by consumers towards more value-oriented items, more affordable goods,” El-Rayes said, elaborating on “Time to reset, reposition and win,” a consumer and retail update to Kearney’s annual M&A survey. Consumers, he added, will stand by the brands they trust. And with heightened awareness around the issues sustainability and circularity, these twin themes could firmly take root when the worst of the pandemic is past.

M&A mindset: what to buy and how much to spend

Despite the pandemic-prompted uncertainty, the COVID-19 disruption offers reasons for optimism, too. “In every crisis comes innovation,” El-Rayes said. The Great Recession, for example, birthed archetypical disruptors like Uber and Airbnb.

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Companies willing to bet on bold risks and invest during an economic downturn often “generate a much higher return on investment than their competitors during a recovery,” he added.

El-Rayes and 57 percent of an executive survey pool believe the lion’s share of near-term M&A activity will generate small transactions of $100 million or less, and midsize deals up to $1 billion.

While one pool of cash-flush investors will be sniffing around for distressed investments—discounted brands in need of a turnaround—another investor class, the financial sponsor and strategic buyer, will be eyeing sound business that might have been too expensive to approach during rosier economic times but now might be open to a tie-up or takeover.

And while global players are pondering the future of consumer spending and shopping, many also are considering opportunities to nurture the apparel supply chain. El-Rayes expects to see a movement away from globalization to what he calls “islandization” in the supply chain, largely as a reaction to disruptive China factory shutdowns compounded by the lack of raw materials availability elsewhere that threatened production in countries like Bangladesh, Cambodia and Vietnam.

“If I’m a big apparel brand, I may delay this season or repurpose what’s already started [in production]. That’s already started, but we will not be surprised to see more local, decentralized supply chains in apparel. It’s more difficult to do because of where the labor is located and the economics of the entire supply chain, but we will see more investment in apparel traceability and finish being done closer to the consumer,” El-Rayes said. Companies will begin to diversify their raw materials sourcing versus relying solely on China, “which is a big shift,” he added.

Companies are also considering how a potential second wave of virus infections could affect their operations, and having learned from the current supply chain turmoil, large corporations “will want to build a dynamic supply chain and production network to anticipate any possible scenario in the future,” El-Rayes said.

Companies striving to future-proof their survival could spark significant M&A investments. Financial sponsors in particular have accumulated about $1.5 trillion in investment ammunition, and they are the most likely to seek midsize deals. With that level of liquidity at their disposal, El-Rayes believes financial players are likely to outbid their competitors.

Executives surveyed for Kearney’s report indicated concerns over the risks of integrating bigger targets, while 54 percent prefer new and alternative brands over established ones. Not all activity will be in the form of a takeover. Partnerships, minority equity stakes, joint ventures and debt options will be explored as risk-reducing strategies.

Furthermore, 70 percent of polled executives expressed an interest in acquiring new digital capabilities as the gap with brands born online continues to widen.

Strategic v. financial buyers and when to jump in

Whether in the best or the worst of times, some companies are always on the hunt for a good deal.

VF Corp., long an active participant in M&A, is a good example of a strong strategic buyer. It doesn’t buy turnarounds, but does keep tabs on possible targets for growth.

The Denver company continues to “actively assess strategic opportunities and believes the disruption caused by COVID could lead to an increase in M&A activity and the availability of attractive assets,” chief financial officer Scott Roe told Wall Street analysts Friday during VF’s fourth-quarter earnings conference call.

VF has the liquidity to pounce when prudent, he added.

“The disruption underway across our sector will undoubtedly provide ample opportunities for strong companies with demonstrated M&A capabilities to create significant shareholder value through inorganic growth,” Roe said.

Amazon is also said to be on the hunt for another acquisition, and has reportedly been in talks with J. C. Penney, which filed for Chapter 11 bankruptcy court protection Friday. While speculation suggests Amazon wants to acquire the retailer outright, some sources point out that JCP is looking to sell some stores and distribution centers to raise cash—which could give the e-commerce titan new real estate at attractive prices.

And even value-focused private equity buyers will pull out of deals if they no longer make sense. That happened recently when Sycamore Partners elected to halt its planned acquisition of Victoria’s Secret. The financial buyer inked a deal with L Brands in February, but with COVID-19’s onset just weeks later, the purchase offered little upside with malls shuttered and consumer spending shrinking significantly.

In fact, deal activity came to a halt when the pandemic struck. “We saw in March and April [that] M&A hit a giant pause,” Brian Salsberg, global buy and integrate leader at EY, said during the Financial Times’ Global Boardroom digital conference last week. Salsberg said $100 billion worth of transactions in April represented the lowest month in dealmaking seen in 15 years. But there were signs of life again in early May, he said, with Facebook taking a nearly 10 percent stake in India’s largest mobile operator, Jio Platforms, for $5.7 billion, and Coty selling a majority stake in the company to KKR in a deal valued at $4.3 billion.

Salsberg expects to see several kinds of deals on the horizon. Legacy traditional deals, such as Facebook and Coty, that didn’t get done before the COVID-19 outbreak will come to fruition, while opportunistic deals will claim distressed targets. And then there’s what he calls the ‘new normal’ deals, which reflect how companies have a new view of the world post-COVID-19.

While he expects oil & gas and media & entertainment to be the top two sectors that could see many deals ahead, the retail sector is expected see some activity. The “nature of retail” creates a more challenging deal environment, Salsberg said, though he expects next year to be “pretty active.” Thousands of heads of corporate development told EY they are “planning on doing transactions within the next 12 months,” he added.

The lack of insight into what consumer behavior will look like also throws a wrench into retail’s M&A potential. How much demand loss is temporary versus permanent remains unknown. The EY executive cited Peloton, the in-home exercise bike company, as an example. “When will I go back to a gym so people can sweat all over me: three months, six months or never?” he pondered, noting too the same thought process applies to movie theaters versus Netflix. A recent EY survey indicated that 47 percent of U.S. households have increased their streaming media consumption, and Salsberg predicts that a sizable percentage won’t be going back to the cinema anytime soon.

Like El-Rayes, Salsberg said total shareholder return for those that were aggressive in M&A activity exceeded those that stayed on the sidelines following the global financial crisis in 2008. Companies that want to get ahead will have to make a move at some point.

“You can only stay sitting in the lobby waiting for the rain to stop for so long. If you move too quickly, you get wet and if you wait too long, all the [good opportunities] will be gone,” Salsberg said.