Harsh Pais
Facebook's $5.7-billion investment in Jio Platforms was announced at the peak of COVID-19 related lockdown. This raises the question of what we could expect of M&A trends in the COVID environment and beyond. It may be too simplistic to say M&A will fall off a cliff or it will accelerate on the back of reduced valuations.
What the headlines about the Jio deal miss is that Facebook's 9.99 percent investment is targeted at a private (unlisted) company with focussed offering. Jio has a leadership position in high-speed connectivity and is proceeding with plans to roll out digital ecosystems on a very large scale. These are unique considerations that must have factored in Facebook's financial and strategic assessment of the opportunity, not to mention Facebook's plans for its own continued growth and expansion in India. By some accounts, Facebook’s investment valued Jio Platforms at more than the sum of RIL’s other businesses.
In general, acquirers are likely to become more selective about opportunities, and cheap valuations will not be the main driver for transactions. While some M&A activity will involve public targets, the majority of deals -- by volume and number -- will likely involve private targets or ‘carve-outs’.
The acquirers are likely to be more discriminating, targeting specific businesses of interest with greater precision while turning averse to investing in other businesses run by the same entity (as a ‘package deal’). This trend will likely be compounded by numerous regulatory obstacles in the way of public company acquisitions, which acquirers will be reluctant to endure in the current environment.
Deployment of fresh capital by strategic acquirers and private equity (PE) towards M&A is likely to be concentrated in sectors that will bounce back sooner – such as tech, IT (information technology), media, consumer goods, healthcare and segment-leading industrials.
Other sectors where the adverse effects of the lockdown are likely to be more prolonged will see consolidation – either for survival, or because scale is necessary to compete with stronger players or to defend margins in the new normal. These include financial services, energy, infrastructure, EPC (engineering, procurement and construction), retail and smaller IT companies. In addition, a variety of ‘non-core assets’, ranging from consumer brands to real estate, will be brought to market to raise capital.
Finally, there will be businesses that are severely damaged by the lockdown -- some of these may have been vulnerable, to start with -- either because their market or revenues have been substantially eroded or because they are overleveraged and heavily reliant on borrowing.
Unfortunately, there will be little M&A activity to salvage such companies as acquisitions in this space will simply be too risky or messy in the current ‘risk-off’ environment. It appears that even bankruptcy will not be an option to recycle such assets as the bankruptcy code has been put on hold, and when it resumes, the bankruptcy infrastructure will be overwhelmed by a logjam of cases.
The PEs are sitting on record amount of capital. However, even private equity and venture capital will be forced to make tough choices on which portfolio companies should get fresh capital (Oyo being a recent example), and which should be jettisoned. Some of the latter category will get sold or merged, but unfortunately, others may be left to their fate.
One might to be tempted to believe that reduced valuations would lead to more deal-making. However, this assumption fails to account for why valuations have fallen in the first place. It also disregards rich valuations that some companies continue to enjoy. At the same time, investors have become more cautious -- as is natural at the end of a business cycle -- and international investors have a broader selection of opportunities available across the world.
In the short term, we may see a return to minority investments and PIPEs (private investment in public equity deals) as a theme as against buyouts as the PEs look to deploy capital in stronger companies and fill the vacuum in the debt market while maintaining a more cautious stance.
Overall, buyers are likely to have an upper hand in the M&A market, and deal terms will reflect this dynamics. Buyers will spend more time and effort evaluating opportunities, and we can expect a greater focus on due diligence, indemnities, earnouts, exit-terms and downside protections.
Harsh Pais is Partner, Trilegal. Views are personal.
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