- We’re in the throes of what will be one of the biggest economic shifts in at least a decade, if not several
- Don’t waste time on what-if retrospectives. What matters is coming out on the other side, into the ‘new normal’
- Expect a pause on M&A now, and longer due diligence processes for the foreseeable future. Private equity is also keeping its powder dry
One of my favorite sayings is the Warren Buffet axiom: “Only when the tide goes out do you discover who’s been swimming naked.” It’s a cautionary reminder that not everything is as it appears, and due diligence is a necessary step in every transaction.
What’s been revealed by recent events is just how prescient the Oracle of Omaha continues to be. But now’s not the time to dissect what brought us to this point. I ordinarily talk about the metrics of wealth creation — gross margin, EBITDA, intellectual property and the like.
Today, however, I want to talk about survival.
In the immediate term, companies that are well capitalized and have strong balance sheets and healthy cash flows (a different metric than EBITDA) are best positioned for success. Take Microsoft and Uber. The two couldn’t be more different in terms of philosophy, profitability or plenty of other metrics. But both are financially positioned to weather the storm — Microsoft thanks to its $134 billion in cash vs. $66 billion in debt, Uber thanks to its variable cost structure and its own hoard of $10 billion in unrestricted cash.
As Uber CEO Dara Khosrowshahi said on a recent analyst call, “In any crisis, liquidity is key.”
Resources available to smaller companies pale in comparison, but the philosophy is the same.
Right now, there are three buckets of companies: Those that may not survive because they couldn’t, or didn’t choose to, accumulate three or four months of cash flow reserves; those on the margin that can probably hang on thanks to good luck or prudent planning or because they have recurring revenue, but that will have their cash flow somewhat or greatly restricted; and those that will continue with business near normal or potentially better. It’s a good time to be a grocery story or streaming provider.
I’m talking to the middle group. It’s the biggest segment by far and is growing every day the crisis continues. For them, I have a few guidelines for success:
First, stay on top of your financials. This is especially critical for project-heavy businesses, which today are experiencing delays and cancellations. Small and midsize companies must prioritize their balance sheets, limit investments and hoard cash rather than aiming for maximum short-term value. At this point, all capital expenditures must be subject to review, and I would expect most transactions to be on hold.
If the balance sheet truly supports a transaction, it may continue — but business owners need to carefully consider the disruptive potential and the impact on capital resources.
This will be a painful shift for growth companies that have historically been financed with payables and were able to borrow against revenue. But the fact is, sometimes you have to pass on amazing deals because of timing. Even the least costly acquisition is too expensive if it imperils your entire business.
Second, remember there are always multiple choices — even if there are no good ones. A bad choice is better than a worse choice, defined as, What protects the company and keeps it viable through the current crisis? While no one wants to make defensive investments or defensive sales, it’s worse to lose everything you’ve built.
No business wants to lose employees, either. But community goodwill is a secondary consideration to business survival. Fortunately, new programs have been announced that may address the layoff/furlough question, and there’s advice and help for businesses on the margin. But I spend all my time working with business leaders, and there’s no unanimity about when or if things will return to normal for many companies.
Employees are important, but the business’ survival is primary.
Third, pay close attention to government relief programs and the resources available to small businesses. Over the course of writing and editing this column, multiple stimulus bills have been debated and reportedly agreed to, and support for small business is a consistent theme on both the state and federal level. The just-passed stimulus bill has some $370 billion in government-backed bank loans that, in some cases, small-business borrowers won’t have to repay. They can help you keep workers and be poised to get up to speed quickly when the time comes.
Fourth, communication is key — now more than ever. It’s not like the CEO went to Vegas and put half the company’s assets on a blackjack table (though that strategy famously worked for Fred Smith at FedEx). Your vendor partners, distributors and OEMs know this is a unique, unforeseeable situation, and they may be able to help. Ask for what you need, such as extending terms. Remember, you don’t ask, you don’t get.
Your customers are facing the same headwinds, but not everyone is affected the same way.
Take a breather and think about whether you can change your relationships for the better, differentiating yourself as a valued provider. Be creative. For example, one of our clients was able to extend payment terms for a customer that was thinking of cancelling its contract. Another example would be shifting a contract to more managed services as on-premises work is less feasible given social distancing restrictions. Larger customers may be able to prepay or accelerate plans. There are tactics to get paid faster that might still work.
Either way, do what you can for them. When this is over, they’ll remember who stepped up. I suspect flexibility will be important both in terms of long-term potential and short-term value — and will ultimately be reflected on the balance sheet.
Finally, work with your bank or financing partner. Draw down whatever you can to help bridge this period and focus on living to fight another day.
So what does the post-COVID-19 landscape look like?
A couple of points: In the immediate term, we’re going to see sharp impacts to multiples and other valuation metrics. I expect to see consolidation, especially among smaller strategic acquirers. A non-majority ownership stake in a larger entity with fewer costs is better than majority ownership of a business that can’t cover its costs due to liquidity problems stemming from this crisis.
In terms of PE, we may see the disposal of weaker assets, but we may also see PE firms that are unable to take the write-downs associated with that strategy instead be forced to sell a larger, better-performing asset.
We all hope that this crisis turns the corner sooner rather than later and that its societal and financial impact is ultimately limited. But even so, longer term, I expect a broader reshaping of the market. Watch for price breaks for public companies that continue long after everything stabilizes, and corresponding discount purchase price offers both from strategic acquirers and private equity firms, historically higher payers.
Other factors to consider are interest rate risks, given the various stimulus efforts, and expect M&A in general to be slower as diligence will be a much longer operation. This will be a combination of businesses needing more information, and drawing out processes to slow-walk transactions.
I’ll close on a positive note. Though it may be difficult to see today, over the next 12 to 24 months, there will be more wealth created than in the previous period — and this wealth will represent real value, rather than paper gains. Things will normalize, and the companies that survive will be in stronger cash positions and, once M&A resumes, will have the ability to acquire assets for less money.
Ultimately, they’ll have more margin for error.
Be on the lookout for opportunities at every level, and be ready to make radical shifts to existing business plans that are no longer reflective of the current economic situation. I’ll be watching Buffett and Berkshire Hathaway to see if they make a large acquisition in the next 90 days; during the financial crisis, Buffett created more than $20 billion in shareholder value with investments in Goldman Sachs, Bank of America, GE and others.
Remember: The tide will come back in. I’ll see you in the water.
Need advice on how to set yourself up for success once we get through this? Check out my advice on how to prepare your company for sale when you’re not for sale and an explanation of why, when it comes to M&A, culture eats strategy for breakfast.
Marty Wolf has been involved in more than 175 IT M&A transactions during the last 20 years, creating over $5 billion in value. In addition to his responsibilities as president of global M&A advisory firm martinwolf M&A Advisors, which he founded in 1997, he actively manages transactions, has been directly involved in the divestiture of seven Fortune 500 divisions, and closed transactions in over 22 countries in segments including IT services, supply chain, and SaaS. Marty also acts as counselor and trusted adviser to CEOs of select IT firms. He has advised on take-private strategies and corporate carve-outs, as well as defended firms in hostile tender offers. He is a columnist and frequent speaker at IT and M&A conferences. Contact Marty via email.