Dynamics Driving Mergers and Acquisitions in the COVID Era
Head of TransPerfect’s TransCEND Virtual Data Room Solutions Group, John Beeman, sat down with Chris Petrossian, Co-Head of Consumer for Lincoln International, to discuss Chris’s view on the mergers and acquisitions (M&A) markets today, COVID-19’s impact, taxes, and what he expects going forward.
John: Can you give us a sense of your current focus in your role at Lincoln International?
Chris: I have two roles at Lincoln. I am Co-Head of the U.S. Consumer Group, and I head the Los Angeles office, where one of my key areas of focus is developing relationships and executing transactions for owner/entrepreneurs in the region.
The Current State of the Market
John: We’ll come back to the local California views. For now, can you provide your take on the current state of the M&A market?
Chris: This is the best I have seen in over 20 years as an M&A banker. There are a few drivers.
One, the stock market is at a record high, which provides strategic buyers a lot of confidence when they're trading at these high values. In addition, corporates have over $2 trillion of cash on the balance sheet receiving low to no interest rate.
Two, private equity (PE) has $1.5 trillion of dry powder. On average, PE invests 35–50% equity in their deals; that means there could be $3.0–4.5 trillion of private equity-driven transactions in the coming years.
Three, the debt markets are very attractive, interest rates are very low, and there's a lot of financing available—not just from the traditional lenders, but also from in the private debt markets. Private debt funds have been a big supporter of middle market activity.
Four, as we come out of the pandemic, there are many sectors seeing an improvement in performance.
Five, there's a view that at some point in the near future, after the ongoing 13-year run, we are likely to see a recession and sellers want to stay ahead of the next potential downturn.
Finally, President Biden has said that he wants to raise capital gains tax rates from 20% to 40%. To put that in perspective, we have clients who are potentially facing a ~57% tax for selling their company (e.g., 40% federal capital gains, plus 3.8% Obamacare tax, plus 13.3% California state income tax). The incremental difference is meaningful. If you're selling a company for $500 million, and capital gains tax goes from 20% to 40%, you are paying $100 million more in taxes. There is no guarantee that taxes are going up, but many of our clients don’t want to take the risk, especially given the strength of the M&A market today.
John: It sounds like because of that capital gains tax increase, the interest rates being low, and some people out there predicting inflation, we’re looking at ultimate conditions. How long do you think that's going to last?
Chris: I believe 2021 will be a record year for the reasons I just stated. I think 2022 should still be a good year, but may not be as strong as 2021.
There is still a lot of capital in the system and continued interest from both buyers and sellers driving M&A activity. The Fed has stated their intention of keeping interest rates low. With midterm elections in 2022, I think we will see more stimulus and government spending, particularly for infrastructure.
When you think about 2020 and 2021, not every company has been operating for a full year at normal capacity due the pandemic and shutdowns. Hopefully, by 2022 we will have a full year of “healthy openness” driving improved performance. It will be interesting to see what happens in 2023.
I also believe there is an inevitable impact on the supply side. Given the strength of the M&A markets and potential capital gains tax increases, many people who originally wanted to sell in 2022 and 2023 brought forward the deals into 2021.
COVID-19 and M&A
John: Can you clarify what you mean by “healthy openness?”
Chris: When you think about it, California, the fifth-largest economy in the world, didn't open until mid-June and even now there are restrictions. Therefore, not a lot of companies are back to pre-pandemic levels or at least will not be back there for the full year of 2021.
Hopefully, by 2022 everybody will be fully open for a full year and have trailing 12 months of performance and revenues to support a good story for investors.
John: What do you think the lessons are to be learned from the COVID period over the last year and a half?
Chris: What we saw was how people reacted and adapted. There were a number of owner/entrepreneur companies who thought they ran their businesses efficiently pre-pandemic.
When I spoke to my clients over the past year, many shared how they improved their supply chains, sourcing, headcount, overhead, operating expenses, and more. They couldn’t receive product from China so they're thinking, where else can we source from?
Whereas private equity does a good job of bringing efficiencies to bear, owner/entrepreneurs took a fresh look at their businesses and oftentimes found there were opportunities to be more efficient during and after the pandemic.
We also saw some companies who were “recession resistant” prove out that they were also “pandemic resistant.” For example, the pet sector has done incredibly well, as there are more pet owners in the US and the “humanization” of pets continues to gain steam. Food companies have also performed well. People were eating at home instead of going out and consumers were trying, and falling in love with, new brands and products.
On the other hand, the industrial sector did not do as well during the pandemic, as manufacturing was slow and, in some cases, closed. Today, the industrial sector is on fire, as manufacturing comes back and 2020 deals are pushed into 2021.
Finally, some companies received a “COVID bump,” so it will be important to show the growth in 2021 is sustainable into 2022 and beyond.
John: Yeah, and not that this is your area—but maybe it overlaps with consumer retail—real estate. I was amazed at how many went under. If you think of malls, for instance—or how many people have these huge footprints all across the country—they couldn't open at all for a year, and managed to survive, so that was amazing.
Chris: I think retail is evolving, and brick and mortar is no exception. Consumers have become both sophisticated at—and reliant on—virtual/online shopping. Whether it is Amazon.com, Chewy, food delivery, or any e-tailer (e.g., Walmart.com or Target.com), you could get what you need delivered to your house very conveniently.
I do think some of that vacant space left by retailers will shift to more of an “experiential” focus, where you're going to go to the mall and not necessarily just buy something and come home, but you’re going there to be a part of an experience. I think we are going to see more restaurants, movie theaters, gaming, sports-oriented, virtual reality, escape rooms, and other places that provide someone a rewarding experience.
John: So we talked about the next year and a half, but what do you think after that? What do you see for the long term?
Chris: I do think private equity will always be active. They have a portfolio that they have to turn and a fund life, so they'll always be buying and selling.
I do think we're going to see a pickup in corporate carve-outs. Corporations have been active with acquisitions and now they have to figure out what's core to their long-term strategy. I can see corporations over the next couple of years selling non-core assets as their strategies shift and they adapt to all of this change.
On the owner/entrepreneur side, I think we have the Baby Boomers getting to the age where they are thinking about retirement or leaving the business to the next generation of family or selling the company. You also have this knock-on effect from the pandemic where some owners/entrepreneurs are looking at the concept of mortality and perhaps pulling up that transitionary point in time.
We had a few clients who were not looking at selling, but were impacted by COVID and decided they would rather exit the business and enjoy their time with their family and pursue other interests. So, I do expect there will still be activity on the owner/entrepreneur side.
John: I saw a recent article published by S&P Global about private equity being bullish in 2021. It aligns with what you're saying; they’re ready to “invest the sizable amount of capital that we have left on the table in 2020.” With that said, what role do you see private equity playing in the post-COVID comeback?
Chris: I think private equity will continue playing a very large role. Private equity has a lot of capital to invest. The public markets on average return 7% per year over the long term, whereas private equity on average is returning 14–15%.
Investors are looking for better returns and believe private equity is a good place to beat the public markets. I wouldn't be surprised to see more money—especially with the stock market already at record highs—moving over to private equity.
John: I've talked to PE folks during COVID, and they were definitely in acquisition mode. In a down market, you scoop up these companies. Now, do they have so much money, to your point, that they're going to continue buying up companies? Do you see them doing a lot of PortCo exits? Will they be focused on more acquisitions? What do you think?
Chris: I think the ones who wanted to exit, given where the markets are, have already taken advantage or will soon. We've heard some private equity firms saying, “I'm selling it earlier than I want to, but I have a responsibility to my limited partners (LPs) to make sure we provide a good return.”
Given where valuations are this year, we've heard a few PE firms pull back acquisition activity. They like companies coming to market, but they just don't want to “overpay.” I think they call it being “prudent.”
On the other hand, some LPs are telling the private equity firms not to time the market and to continue investing as the LPS are invested across various asset classes for the long term already.
What’s Happening in California
John: So, let's talk about your firm. Can you speak specifically to Lincoln International’s focus or strategy on M&A going forward?
Chris: We want to continue growing across all three client categories—corporates, private equity, and owner/entrepreneurs—by providing the best advice possible. The focus has to be on that strategic guidance we share; it’s a firm-wide focus on what we call “Real Connection. True Perspective,” strong relationships rooted in insights that help clients realize their goals.
Also, we believe our platform is uniquely positioned to take advantage of the growth in cross-border activity with 22 offices in 16 countries.
John: Now, let's bring it local. What are you seeing locally for California from your position as head of Lincoln’s Los Angeles office?
Chris: As we discussed, California, in essence, was closed for 15 months. Think about that: the fifth-largest economy in the world was closed for 15 months and even today it is not fully open.
As we slowly open up California and focus on getting back to “normal,” restaurants are getting back to full capacity, retail is open, movie theaters are open, theme parks are open, and more. As people become more comfortable with travel, tourism will also help California. I do think California is going to receive a boost as the state opens up, which should help companies that are headquartered in this area.
John: And what about the consumer retail sector specifically?
Chris: If you think about all of the people who are sitting at home, not spending, other than online, there is a pent-up demand to go to restaurants, movie theaters, sporting events, concerts, and more. I hope as more of the state opens up, we can put more people back to work, which should continue to improve consumer spending.
The biggest challenge I keep hearing from companies is finding employees.
John: What about the broader market?
Chris: I do think that once employees come back to work, hopefully in the fall of 2021, that will improve. Small businesses are the backbone of America. I think big corporations like Walmart and Target did well during the pandemic. A lot of small businesses, owners/entrepreneurs, struggled during the pandemic, and now we're starting to see small businesses come back.
John: Agreed. Lastly, do you any specific advice for those who have deals coming up—to the buyer or seller, bankers, etc.?
Chris: Right now, there's a record number of deals in the market. The key is to be differentiated and to get buyers to focus on your deal.
On the sell-side, I would focus on the proper positioning of the story and materials that reflect that differentiation, along with running an effective process to the right buyers to get a successful outcome.
On the buy-side, it is important to also be differentiated. Price is important, but you can do your work upfront (e.g., quality of earnings, legal diligence); spend the time to get on the plane and meet with the sellers.
This market is not just about price. Be different and compelling and try to win on fit, certainty of close, and speed, especially as we get closer to year-end and possible tax increases.
John: Excellent advice. Thank you for your time, Chris.
Chris: My pleasure. Thanks, John.
More about Chris Petrossian
Chris co-heads Lincoln International’s Consumer Group and heads the Los Angeles office. He actively markets the firm’s services, manages key client relationships, and leads all aspects of deal execution for publicly traded companies, financial sponsors, and their portfolio companies and owner-entrepreneurs. With over 20 years of mergers and acquisitions (M&A) advisory experience across a variety of industries, Chris has successfully closed over 100 transactions totaling over $50 billion in value.
More about John Beeman
John is based in TransPerfect's Los Angeles office and has 20 years of experience in the financial services industry, with a primary emphasis on virtual data rooms (VDRs) for M&A transactions. Over his career, John has focused on consultative solutions for senior leadership and business users within corporations, banking and finance organizations, and law firms, and currently leads TransPerfect's TransCEND solutions group.
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