Reading Between the M&A Activity Headlines

Unfortunately, the headlines surrounding M&A activity in the first half of the year were not just headlines. Aggregate deal volume and value in the middle and lower middle markets hit multi-year lows due to the unprecedented times and its profound impact on the economy. What the headlines won’t tell you, however, is that when you zoom out of the aggregate analysis and zoom in on specific sectors, geographies, and deal types, outliers begin to emerge. 

PE’s Percentage of the Deal Pie 

Over the last 5 years, private equity backed transactions represented roughly 50% of all completed deals in the US. In the second quarter of 2020, private equity accounted for almost 62% of deals. A sharp decline in corporate backed acquisitions paired with PE’s ability to react more nimbly to the pandemic are a few reasons behind this significant change. 

Pandemic Proof Industries and Deal Types

Aside from the percentage increase in overall deal activity, certain sectors within PE actually remained relatively unimpacted throughout the first half of the year. For example, deal value in the tech reached $14.9B in Q2, nearly identical to the prior two quarters. Interest rose in select industries such as contactless purchasing, workforce management solutions, digital transformation, cybersecurity, and data analytics, as these segments all displayed stable or growing demand through the lockdown. Importantly, the developments in these portions of the tech sector are likely to display an acceleration of existing trends, rather than simple temporary surges in demand. Similar trends were seen in consumer non-cyclical, media, and healthcare, with particular interest in telemedicine.

Finally, while the aggregate numbers may suggest a freeze in all M&A activity, PE firms instead refocused capital deployment by deal type at the height of the crisis, with a shift to immediate-term investing and rescue financing. Alternative strategies such as joint ventures, PIPES, and distressed debt became more popular, at the expense of leveraged buyouts due to factors like credit tightening and soaring valuations.

Emerging Trends and Looking Forward

PE firms responded rapidly to the economic shock in the first half of 2020, adopting an opportunistic, wait-and-see approach. This suggests that there could be a quick resumption in M&A activity as the economy stabilizes, and there are indeed early signs of a rebound with some reshuffling priorities. In a recent webinar, Bain & Company unspecifically reported a busy pipeline of diligence activity that should translate to higher volume in the back half of the year. The turnaround could be driven by record amounts of capital sitting on the sidelines ($1.7T as of July), improving availability of credit, and rising business stability with renewed focus on operational resiliency. 

All that said, a full return to prior M&A activity levels is likely to be slow and steady. Corporate revenue and earnings growth will continue to be challenged by lingering economic issues tied to high unemployment and consumer discomfort with public and social activities, which should shape PE decision making. 

The remainder of 2020 will probably shake out to be a mix of pre- and post-COVID environments. Current pipelines are heavily weighted to the healthcare and tech sectors, the members of which are enjoying more certainty in their operations and outlook. Software tuck-ins are gaining traction as larger entities seek to gain market share through wider portfolios. JVs and partnerships are becoming more important as companies look to quickly address competitive deficiencies and capability gaps. Large companies looking to return focus to core competencies should fuel an uptick in divestitures. Deal volume in the short term will likely be shaped by these opportunistic investments and strategic alignments. Challenges certainly abound for M&A, but it is not all doom and gloom for the back half of 2020.