Mergers And Acquisitions: A Market Window

There has been quite a flurry of M&A activity lately, sometimes including the private banking sector itself. The author of this article says there is a “market window” that is favourable for deals due to attractive valuations.

Market resilience and current valuations contrast with the collapse of 2008. This trend is explained by a number of supporting factors, including the significant presence of investment funds. As shown by deals as recent as this week’s Avaloq/NEC and Intesa Sanpaolo/REYL deals (see here and here), M&A is busy in the wealth management sector. And wealth managers themselves need to understand the dynamics of M&A across the corporate world as a whole.

This article is by Arnaud Petit, managing director at Edmond de Rothschild Corporate Finance, part of Edmond de Rothschild. The editors are pleased to share these views. Jump into the conversation if you want to respond. Email the editors at [email protected] or [email protected] 

As Warren Buffet likes to say: “You never know who’s swimming naked until the tide goes out.” Exogenous shocks generated by crises throw a harsh light on the real state of the market, and excessive risks taken by investors are plain to see. The subprime and sovereign debt crises were good illustrations of this phenomenon. But while the financial shock of 2008 had an immediate impact on mergers and acquisitions and resulted in valuations plummeting, what can we say about the effects of the coronavirus crisis?

Firstly, we should note that there was a boom period for M&A prior to lockdown, in terms of both volumes and average valuations. The Argos Index tracking valuation multiples for private deals broke through the threshold of 10x EBITDA at the end of 2019, versus a multiple of 8x five years earlier. Although the market was significantly affected by the months of general lockdown, subsequent months have been rather encouraging, unlike the situation experienced in 2008. How can we explain that?

Vigorous growth of investment funds

The mergers and acquisitions market today is driven by investment funds, which account for over half of the deals done. In France, for example, they raised €21 billion in 2019, versus €17 billion in 2017. These funds value businesses better than industrial companies do, the counterpart of which is lower expected returns. Over 10 years, target private equity returns have thus fallen from around 25 per cent to a range of between 17 per cent and 20 per cent.

A robust debt market

In addition, and in contrast to 2008, commercial banks have healthy balance sheets. After a period tied up with granting government-backed loans, credit institutions have returned to their more normal business. The disintermediation of debt must also be emphasised as a factor that provides support for mergers and acquisition activity. Debt funds are becoming a real alternative to bank loans. They raise money from institutional investors to lend to companies and investment funds. These funds doubled the amount of money raised to €4 billion between 2017 and 2019.

Flight to quality

It is also worth noting that the trend among investors is to look for lower risk investments, as happens in every financial crisis. This flight to quality is leading to a scarcity effect and is pushing up valuations. In the first half of 2020, more than 15 per cent of deals were done at multiples in excess of 15 per cent  EBITDA.

Whereas healthcare, energy, education and technology are showing sharp rises in value, the retail, aerospace, transport and hospitality sectors are suffering, which, at the same time, creates opportunities for consolidation.

The virtues of consolidation

The vulnerability of some companies is pushing them into joining forces with stronger companies, and even into accelerating their external growth with the support of financial partners. These platforms for consolidation are particularly popular in industries that are still very fragmented. Investment funds are seeking to reproduce the example of the healthcare services sector where there have been numerous link-ups between medical analysis laboratories, private clinics and retirement homes in recent years.

Ex-coronavirus EBITDA

Finally, the mergers and acquisitions market has become more professional and sophisticated as a result of the growth in the number of deals brokered by financial advisors. This intermediation has led to best practices becoming widespread, which is beneficial to deal transparency and the quality of information. For example, communicating an adjusted EBITDA figure corrects the accounting multiple for any elements assessed as being non-recurring. The use of EBITDA©, as an adjusted, standardised, annualised, pro forma EBITDA allows calculations to be based on a year that excludes the impact of coronavirus, because of its exceptional nature. Now largely accepted by the financial community, this practice brings the position of buyers and sellers closer together.

The market window is therefore favourable, with attractive valuations for resilient and defensive assets responding to investors’ current criteria. While prudence is still called for in 2021, which is already looking like a pivotal year, historic government stimulus packages and central bank action also give us grounds to remain optimistic.