Part 4 of the PwC series Succeeding through M&A in uncertain economic times
During any period of uncertainty, companies, private equity firms and other potential acquirers must weigh adjustments to investment strategies. Compared with previous economic cycles, the amount and diversity of capital available for M&A is substantial. Companies that can leverage that capital and make deals early in a downturn could see better returns than others in their industry, a PwC analysis found. But for that growth to be realized, those companies have to be prepared. As we approach times of greater uncertainty, it’s important to revisit M&A best practices and how they’ve changed over this past economic cycle.
When focusing on best practices, issues to address include deal strategy and leadership, capital, customer experience, operations and workforce. Actions and tools include scenario planning, cost optimization, data analytics, reskilling and automation. In these critical areas, companies need to consider three key things:
- What we know from before: lessons and best practices from past recessions
- What’s different: the characteristics of the current cycle and differences from past cycles
- Looking forward: current best practices for being prepared to do deals in times of economic uncertainty
Agree on growth opportunities and act with confidence
The psychological effect of uncertainty: Economic uncertainty understandably tests the risk tolerance for company boards, management teams and investment committees, often causing hesitation in deploying large amounts of capital. At the same time, a declining stock market makes shareholders more anxious. Previous downturns have seen increased shareholder activism, as some investors pushed for action to cut losses and inject capital, such as divesting certain businesses.
New business models will emerge: As established companies, entrepreneurs and consumers adjusted to shifting conditions, new business models have emerged during past recessions, disrupting the M&A environment. The rise of ride-sharing firms after the Great Recession is one example.
More stakeholders are watching: Greater connectivity means greater visibility of businesses, and a downturn likely would bring more scrutiny from not only investors but also the public in general. Reporting and criticism of companies have expanded beyond newspapers and television to social media. The consequences of actions during a slowdown – from short-term employee layoffs to acquisitions aimed at long-term growth – will be judged not simply as dollars-and-cents decisions but for how they reflect on a company’s contributions to society as a whole.
4IR investing opportunities: Artificial intelligence (AI), the Internet of Things (IoT), 3D printing and other emerging technologies continue to mature, and companies in many industries are exploring how the Fourth Industrial Revolution (4IR) could upend processes, operations, products and services. Unlike traditional bids to grow scale, investments in 4IR technologies don’t necessarily have to be substantial to help a company start down a path of transformation.
- Consider strategic divestitures: Investors should proactively assess their portfolios and determine if a near-term divestiture aligns with their business strategy and could boost their capital position even more. Connecting the growth strategy to portfolio management creates a feedback loop that allows the company to adjust for various scenarios – including the severity of the next economic cycle. That’s a contrast to reactionary moves that too often result in strategic misalignment and value leakage.
- Adjust metrics and benchmarks: The metrics that drive the share prices of public companies may not change during a downturn, but some could take on more weight than others. Companies should revisit their value driver analysis for those metrics and adjust their analytic tools to monitor and prioritize key metrics for downturn scenarios.
- Ensure optionality in the deal funnel: The above actions can put a company in a better position to reassess the corporate development deal funnel and determine which prospects are clear priorities in a downturn and which assets may come to market in a tighter economy. Recent history is less relevant than scenario analysis, which will be critical for target assessment.
- Keep communication front of mind: Proactive dialogue between management and corporate development teams and the board of directors and investment committees can build confidence that the company is current on the competitive landscape and prepared for a range of scenarios. That will be key to ensuring prompt responses to M&A options.
Preserve access to and efficiency of capital
M&A capital declines in a downturn: Public equity, private capital and borrowing all have played a role in helping companies acquire others. The 1990s saw public equity play a larger part, as private equity firms had yet to assert themselves and interest rates – while falling – still weren’t as competitive. But declining stock markets during a recession reduce the value of shares, limiting their attractiveness in trying to assemble deal funding.
Debt can be more difficult to manage: Borrowing also became harder for companies in previous downturns. Rates typically fall, but so do companies’ values and performance trajectories, which can affect the risk conversation. Companies also may face more pressure to meet loan terms and covenants that may have seemed favorable in an expansion but don’t hold up as well amid declining revenues. Working capital also becomes a more critical focus, as financial and operational inefficiencies can jeopardize stability in a downturn.
Private capital flourishes: Compared to the last recession in 2007-2009, the next downturn is expected to be less severe, and capital available for investment is not as closely linked to economic trends. While bank lending into deals has declined as a part of overall M&A capital, the rise of private debt funds, venture capital and private equity has greatly expanded the amount and mix of capital.
Companies hold more cash: Corporate cash has grown substantially over the past decade. Profits are generally up, while spending on tangible assets has tapered off, as a greater percentage of investments has shifted to intangible assets. The lowest corporate tax rate since the 1930s has helped balance sheets swell further, giving companies that see limited paths for organic expansion more liquidity to pursue deals.
More debt options, but with potential risks: While abundant and diverse, the capital mix isn’t bulletproof. Debt markets have expanded significantly, and loans issued by some institutions typically have fewer covenants and more flexibility than those from banks. But some of that capital could cost more in a slower economy. In the bond market, the lower investment-grade bonds that have become more common could put some companies at greater risk of downgrades and default as economic conditions worsen.
- Explore where to restructure debt: On the borrowing side, companies should review their current plans and determine where they could restructure or refinance. They also should review how covenants could change in a downturn, as some alternative lenders may seek more protections, even if not at the level of those required by banks.
- Right-size working capital: Focus on improvements in the relevant operating levers to ensure working capital is tuned to a declining cycle. Reductions in inventory (which could be affected by decreased demand) and receivables (declining revenue growth) and improvements in payables are reasonable aspirations during an economic decline. These can increase operational efficiency overall and result in a stronger capital position. Benchmarking, data analytics and other tools can reveal both short- and long-term possibilities.
- Consider capital mobility: Private equity firms should determine where they could move capital among their various pools to maintain adequate returns as some portfolio companies feel the impact of a slowdown. Firms engaged in alternative investments and private debt as well as equity should leverage that flexibility to avoid capital being trapped in non-productive situations.
Plan for customer experience challenges and improvements
Customers feel the pressure: The rules of customer engagement change with the economy. Companies that fail to understand financial pressures on their customers and don’t anticipate changes in buying patterns can find themselves facing sudden, unexpected revenue declines. And when management focuses primarily on cutting costs to offset declines, a company can lose sight of the impact on clients and customer experience.
Internal issues can affect external perceptions: There’s also the potential impact of internal communications on customer experience. Employee anxiety during economic uncertainty can spill over into customer engagement, damaging relationships at a critical time. Customers who sense a company is vulnerable in a downturn and has neither a short-term plan nor a long-term vision are more likely to consider alternatives that could better serve them going forward.
Data delivers deeper ties with customers: Whether it’s B2B or B2C, customers are open to deeper relationships with companies through technology. They recognize the benefits of connectivity and customization, and the proliferation of e-commerce business models and social media platforms has made for a richer customer experience in many industries. Social listening and sentiment analysis provide more insight on consumer preferences and behaviors that can be used to strengthen ties.
Relationships can change quickly: But customer loyalty also is more complex in a digital world. Products and services tailored to specific needs have appeal, but customization doesn’t displace traditional demands, such as competitive pricing and fast service. Customers can quickly end relationships if they experience gaps in key areas.
- Prioritize customer needs: On a regular basis, companies should determine what aspects of their particular customer experience are most important and what they need to do to preserve them. This could vary by industry, and concrete resources should be identified to safeguard the quality of engagement and maintain a company’s customer base so it can consider building on it through M&A.
- Capture sentiment directly: In making an acquisition in the downturn, understand sentiment and develop a process to conduct that analysis early in the deal. Learning from customers of a target business can be a valuable complement to dialogue with management. Listen to the themes. In addition to customer opinions and expectations, sentiment can provide another lens into the workforce – a key part of the customer experience.
- Analyze to retain and expand: Use analytics to determine what customer retention incentives are more important in a slower economy. Being able to deploy those quickly in response to customer anxiety will ensure a company remains stable and better able to acquire in a downturn. Analytics also can identify areas of potential customer expansion in acquisition targets, which can increase deal value as the economy eventually improves.
Ensure consistency while adjusting operations
If reductions are necessary, they should be focused: Offsetting revenue declines with indiscriminate, ineffective slashing can be damaging and should be avoided. Focused cuts should be calibrated to lower volume expectations.
Opportunities to simplify: In the past, downturns have prompted companies to invest in simplifying processes and improving productivity, putting them in a stronger position to potentially acquire other assets later.
Shifting supply chains: The extension of supply chains to countries around the world, especially China, over the past two decades has made the companies that rely on them more vulnerable than in previous recessions. Tensions between nations pose threats to long-standing relationships and processes, and US companies now must consider the financial impacts of a more bilateral and protectionist world.
Digital tools expand: Increasingly sophisticated digital tools and data analytics have improved visibility and information across operations as physical locations have become far flung in many industries.
AI and other techs emerge: US worker productivity has declined for the last several years, requiring acquirers to consider what they would need to do to improve efficiency in potential targets. Further adoption of 4IR technologies ultimately could have a significant impact on how business models evolve in several industries.
- Revisit pricing and incentives: Adjustments to revenue paths can’t wait until the economy worsens. Companies should revisit pricing strategies early and often, as well as sales force incentives, and plan for various degrees of decline.
- Position supply chains for the long term: Supply chain agility will be more important going forward. Along with adapting their own chains, companies should secure capabilities to evaluate how tariffs – existing or possible – and other disruptive factors could affect the supply chains of acquisitions.
- Find efficiencies in shared services and PMO: Corporate and private buyers should have clear plans for shared services – locations, automation or otherwise – that can then be leveraged for potential acquisitions to generate immediate savings. Procurement, demand planning, accounts payable and performance reporting are a few areas where a buyer could quickly fold in a new asset. Project management office (PMO) practices and discipline also can pay significant dividends in times of turmoil, whether for integration readiness of an acquisition or effective execution of organic transformation initiatives.
Recognize the value of the workforce
Staff cuts can drain talent: A business under economic pressure can feel it everywhere – from the C-suite to the front lines. In tough times, experience matters. Leaders who appreciate the challenges of operating in a downturn are more likely to pull the right tactical levers to ensure stability and keep the organization on a growth path. That extends across the organization. The need to cut costs may be real, but sweeping layoffs can jeopardize recovery due to the loss of key talent and institutional knowledge.
Communication and context can boost culture: Timely and informed employee communication is always critical to business success, but especially during periods of economic uncertainty. Efforts to create and advance a unified, inspirational culture can be undone quickly when employees don’t see the same level of engagement as during an expansion. Companies that discuss the temporary issues in the context of a larger journey can instill more confidence in their teams.
Unprecedented workplace diversity: We are witnessing the emergence of a multigenerational workforce with the widest age ranges in history. With greater diversity of age, race, ethnicity, beliefs and experience in general, employees often have an array of priorities and goals, which makes broad policy decisions and implementation more difficult.
Diverse behaviors and new incentives: Technology has enabled an overhaul of the typical workplace, which requires better understanding of the people element of businesses. Whether it’s flexible workspaces, contract versus full-time work, or greater willingness to take personal time now and retire later, many companies and employees are casting aside traditional workplace expectations. That influences employee incentives, including those in play during M&A.
Greater purpose and participation: Many companies understand that employees care about more than salary and benefits when it comes to where they work. Feeling valued as more than a cog in a machine and that they’re part of an organization with a purpose beyond profits is more important than before. And companies have responded by supporting employees’ well-being and encouraging innovative thinking that solves problems and introduces new ways of working.
- Assess the people in place before acquiring more: Ahead of any acquisition, companies need to revisit their overall workforce structure, including spans of control and layers. This can provide fresh perspective on how the workforce composition has evolved and how models can be adjusted to serve the current organization and new assets.
- Keep growth in mind: Confirm the talent needed to deliver on growth areas. Potential buyers also need to ensure their processes to evaluate and retain employees at an acquisition during an expansion are still appropriate in a slowdown, especially given the potential customer impact; in PwC’s CX in M&A survey, 88% of consumers see retaining staff during M&A as important.
- Provide skills that help in the long run: Reskilling employees has become more important regardless of the economy, as technology disrupts models and presents opportunities. Companies should consider what training and skills programs could benefit existing employees who otherwise might be replaced. Leveraging employees’ knowledge of the company and arming them with new ways to be productive — especially in growth areas — can inspire more collaboration.
Next steps for successful deals in a downturn
The prospect of making a deal in an uncertain economic time can be daunting. But the idea of acquisitions being off-limits in a downturn is living in the past. Companies that leverage historical best practices, informed by the recent changes to the business environment over the past decade, can have significant success in creating value.
- Deal strategy and leadership confidence: Consider strategic divestitures and adjust metrics and benchmarks. Update the deal funnel for various scenarios and keep communication front of mind.
- Capital availability: Explore where to restructure debt, right-size working capital and take advantage of capital mobility.
- Customer experience: Prioritize customer needs, capture sentiment directly, and analyze to retain and expand the customer base.
- Operations: Revisit pricing, position supply chains for the long term, and find efficiencies in shared services and the project management office.
- Workforce: Assess the people in place before acquiring more, keep growth in mind during cuts and provide skills that help in the long run.
This part of the series has been updated since its original publication in December 2019. Visit our website for more on responding to the potential business impacts of COVID-19.
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