Amidst the chaos gripping the world, the deal market has been hit hard. However, it seems that there are still opportunities for investors in sectors that are resilient or even benefitting from the current crisis. In addition, companies that are struggling and in need of funding present opportunities for investors, potentially at attractive prices.
In this article, we look at the opportunities as well as challenges the current climate presents to deal making and the importance of carrying out due diligence, including things to look out for in your valuation.
Opportunities are still there despite the pandemic
It’s staggering to think just how much has changed over the course of the last few weeks. However, there are still opportunities to invest. Indeed, with interest rates at historic lows and significant amounts of capital available in the form of ‘dry powder’, now might be an opportunity for investors to complete the deals of a lifetime. We are already seeing the middle eastern sovereign wealth funds investing, for example the Saudi PIF has recently invested in both cruise operator Carnival and Newcastle United.
There are many sectors that are actually thriving during this time and here we take a brief look at what is happening in some of those sectors.
Technology, media and telecommunications
Unsurprisingly given the lockdown and working from home, there has been an increase in the use of many TMT services. These include online streaming services such as Netflix, as well as video conferencing software such as Microsoft Teams, Google Meet, Skype and Zoom. It was noted that approximately 44 million people set up Teams in the first few weeks alone.
Working from home, as a result of social distancing measures implemented, has also seen an increase in the usage of subscription software like Firefly for schools. Business offering remote IT support are also expected to do well.
Retail and logistics
With most shops closing their physical stores, customers have turned online to purchase goods that can be delivered. As a result logistics and e-fulfilment companies have seen a huge rise in demand for their services. Food retail saw a huge uptick from panic buying, but will remain at higher levels while people work from home and restaurants are shut.
Home gym equipment
Have you tried to buy a kettlebell in the last month? Don’t try – they are sold out as everyone that was formerly going to a gym is now training at home. As a result sellers of home gym equipment and services such as online training have seen huge increased activity.
Many of the changes noted above are just accelerations of trends that were there already and so will likely continue even after the crisis ends.
Other sectors, notably airlines, entertainment, hospitality and non-food retail are really struggling and are dependent on government support to survive. Here, there will be many opportunities for daring investors at attractive prices. These could provide very healthy returns once the economy recovers, assuming the businesses are fundamentally sound.
Tips for due diligence and valuations
If you are looking at completing a deal in this environment, what should you look out for as you complete your diligence and how should you go about valuing the target?
Many businesses will be taking longer to get paid by their customers and there is an increased risk of bad debts. Buyers should ensure that there are adequate provisions for bad debts in the completion balance sheet, although at the moment that is not easy to assess.
Similarly, there is a risk that inventory is not saleable and should be written down. For example, spring/summer fashion collections will become unsellable. There is also estimated to be 50 million pints of beer in shuttered pubs that landlords will be forced to throw away.
Businesses will be delaying payments to their suppliers. This would include delayed tax payments, even if allowed by the government. Any ‘stretched’ creditors - that is, those beyond their normal or contractual payment terms - should be treated as a form of debt and adjusted in the purchase price. These creditors will have to be settled post-transaction.
Most valuations of businesses are driven by the future expected cashflows. Predicting the future is always hard, but it is even harder during times like this. Forecasts should include different scenarios and it is probably appropriate to apply a higher discount rate to cashflows to reflect the inherent uncertainty.
To summarise, we believe there are still opportunities for investors. However, in complex times, you have to be extra diligent and make sure your valuation is appropriate.