Tomorrow's deal dynamics: How new ways of being are reshaping M&A

Part of a PwC series on new deal drivers in the COVID-19 recession

The COVID-19 pandemic and economic recession are causing significant shifts in individual and group behavior, business practices and social norms. These shifts are influencing consumer decisions and business operations and reshaping the types of M&A and other deals companies will pursue in the months and years ahead. Companies that successfully execute deals usually excel in finance, strategy, operations and process management. But the recent health crisis has shown the need for these core skills to expand, with sociology and psychology also being considered in M&A strategies and tactics.

As history has shown, crises prompt change. World War II led to a surge in women’s participation in the  labor force. The Sept. 11, 2001, attacks altered transportation and security policies around the world. China’s 2003 SARS outbreak changed consumer attitudes toward shopping, leading to the rise of Chinese e-commerce giants while accelerating the launch of digital payment platforms.

The economic and sociological consequences of COVID-19 will endure for years as well. Pandemics can mark “the beginnings of new ways of being and of thinking,” author and historian Jon Meacham said, referring to the Black Plague in the mid-1300s. The COVID-19 crisis is another inflection point, and below we explore six fundamental changes in the deals environment we believe will likely persist in the long term.

 

Prolonged uncertainty: The deal playbooks of past crises no longer work

Until a vaccine is discovered and widely distributed, the health crisis likely will continue. It may be episodic, with outbreaks in different regions at different times — forcing lawmakers to mandate social distancing, mask wearing and other measures that will affect businesses.

Corporate outlooks reflect this uncertainty: From Jan. 1 through July 31, 2020, 851 US companies suspended or withdrew guidance on expectations of the market, compared to just three in 2019 and 27 in 2008, the height of the Great Recession, according to a PwC analysis of Capital IQ data. Our analysis also found that the scale of uncertainty has brought unprecedented disagreement across leading economic forecasts.

Even after a vaccine is developed, health concerns will likely linger and extend this period of uncertainty. In more typical crises, past experiences dictate many aspects of how businesses respond, from formal strategic planning to the heuristics or judgment shortcuts that individuals use to execute business daily. As the health crisis continues, dealmakers are realizing that their previous “downside” playbooks no longer apply.

Deal implications

  • Deals will be smaller. As market volatility weighs on the value of companies, deal size has declined considerably; the first half of 2020 saw only nine US megadeals — those of at least $5 billion in value — down from 35 a year earlier. Instead of large transformational deals, buyers will likely favor smaller targets that may be easier to integrate and allow them to place multiple manageable bets, including in other industries.
  • More deals will include earnout provisions. Unpredictable markets can make it harder for buyers and sellers to agree on price. Earnout provisions can help bridge those differences. Since the start of the recession, our deal teams have seen an increase in discussions about deferring part of an acquisition purchase price until the seller achieves certain milestones or performance metrics. The greater uncertainty also has led to some earnouts featuring longer durations or using different metrics.
  • Multi-scenario planning will be critical to modeling value. More than ever, dealmakers will need to proactively plan for multiple scenarios. That means taking into account not only the best- and worst-case scenarios, but also other factors like the timing of transactions and industry changes due to the pandemic. Simply adding a risk premium to the discount rate won’t be enough.

Concepts of space: Workforce needs rapidly change how companies integrate

Never in our lifetimes have concepts of social space been more heavily debated. It’s also more evident than ever that physical space and social interactions are intertwined into the very fabric of our society. This has created a wide range of impacts, including early signs of a reversal in decades-long urbanization trends. Homes have become the nexus for education, entertainment and most family activities.

Nowhere is the debate around space more apparent than the rise of working from home. According to a June 2020 PwC report, most office workers said they want options to work remotely at least once a week, while 55% of executives surveyed expect to offer that choice. Traditional offices won’t become totally obsolete; the survey also showed half of US executives said they’ll need more office space due to longer-lasting requirements for social distancing or workforce growth. But working from home will likely be semi-permanent at many businesses.

Deal implications

  • Reevaluate workforce compensation and rewards. For buyers planning to integrate an acquired workforce, engaging and retaining talent has often been challenging. According to PwC’s 2020 M&A Integration Survey, two-thirds of companies said access to key personnel was a top priority, but few said it was completely achieved. Today’s US workforce spans five generations, each with different needs. These differences influence how companies manage talent, which will now be complicated by remote work. For example, mid-career employees balancing new family obligations, including at-home schooling, may value flexible schedules and vacation time more than money. Such shifts should be considered in assessing workforces during a deal.
  • Understand the next wave of workers. While the health crisis has affected people of all ages, the long-term effects on Generation Z — those born from the mid-1990s to the early 2010s — could be particularly severe. The disruption to structured learning will likely be one of many pandemic consequences shaping their needs, expectations and abilities as they enter the workforce. That could test dealmakers’ traditional methods of determining the value of a workforce in an acquisition or divestiture.
  • Elevate training and communication. The new nature of work in many industries means it will be critical to evaluate and ensure proper levels of digital training for employees — something that may be lacking among parties in a deal. And as companies look to integrate acquisitions, frequent and focused communication will be critical to compensate for limited in-person interaction, provide clarity and help with retention.

The need for resilience: The quest for efficiency takes a back seat

One of the most consistent business concepts of the last 50 years was the drive for efficiency, with its greatest manifestation the development of global supply chains. These chains became the engine for delivering low-cost goods throughout the globe — not only reducing labor costs but helping build single sources of supply that created further cost advantages through scale.

For many companies, the drive for efficiency led to reliance on China, due to its advantages in both cost and scale. Geopolitical tensions have challenged the relationship with China over the last several years. Now, supply-side vulnerabilities during the health crisis have given this shift additional momentum, further driving doubt into the concept of single sourcing. The fact that production of many critical goods, such as essential medical supplies, is concentrated in China magnifies these tensions.

As a result, many companies are focused on supply chain vulnerabilities. From January to May 2020, earnings calls of the world’s 2,000 biggest listed firms mentioned supply-chain disruption nearly 30,000 times, up 30% from the same period in 2019, The Economist reported, while mentions of efficiency decreased 17%.

Deal implications

  • Vertical integrations fall out of favor. Expect to see less vertical integration in the long term, as companies focus on core functions of their business and potentially outsource other functions. In turn, this will likely drive companies to sell assets that no longer fit with their core business.
  • Investments increase in new supply chain technologies. The need to pandemic-proof parts of the supply chain is steering capital toward previously underfunded areas, such as risk management and warehousing tech, according to a June 2020 Pitchbook report. In the second quarter of 2020, venture investors committed $2.5 billion in supply chain tech companies in North America and Europe. That was more than double the amount in the first quarter.
  • Develop more agile tax models. Companies will need to evaluate tax models that anticipate short and long-term considerations, including extraordinary costs, supply chain disruptions and softened business outlooks. In the short term, companies can leverage opportunities that include maximizing deductions and benefits provided through COVID-19 relief legislation passed in various jurisdictions. In the longer term, they can consider measures such as evaluation of transfer pricing models for sharing risk/loss, impact on structural effective rates and M&A scenario planning.

New consumer behaviors: Innovation could define buyers from sellers

The shift in shopping patterns suggests consumers will be more selective than ever – not only with what they choose to buy, but also how they prefer to shop. As the economy recovers from the health crisis, most consumers also are unlikely to return to normal spending levels even as stay-at-home orders are lifted, according to a May 2020 PwC survey of US consumers.

This signals that even as health risks subside, consumer tastes and preferences will become more uneven and complex. For example, some consumers will be more willing to fly while others won’t book a reservation unless they can easily cancel. These, and other changes in consumer behaviors will emerge differently across age groups, making it even more important to segment individual markets when making business decisions. 

Such trends could have wide-ranging deals implications. Investors will place a higher value on companies that can quickly adapt to new consumer behaviors, and these adjustments could take shape in different ways. Take fast-casual restaurant chains, for instance, with some companies planning to invest in more drive-thrus with separate lanes for digital order pick-up.

Those businesses willing to innovate to meet consumer needs in the recession can not only build customer loyalty but also be strongly positioned to take market share in the years ahead. Given the sweeping impacts of the pandemic, companies that operate with the common good in mind — from creating a safe environment for employees and customers to assisting those hit hardest by the recession — can come out ahead.

Deal implications

  • Reassess potential buyers and sellers. Consumer behaviors are contributing to shifts in the directions of many industries. Within sectors, some companies have stronger capital positions than others. Both of these could create “K-shaped recoveries” — with companies on either an upward or downward trajectory, both within certain sectors and in the economy as a whole. That not only could determine who is a buyer and who is a seller, but also how a company’s value is assessed, considering previous growth models no longer apply.
  • Enhance tech capabilities and explore tech transfer. Sellers that can show how investment in new or existing technologies has paid off for customers and kept business stable could command more value in a transaction. Conversely, buyers need to assess how tech that has been successful with a target’s customers could be applied to other businesses during integration. For example, a customer app that has thrived for one restaurant in a curbside and contactless society could work similarly with others. In other cases, an acquirer should ensure that an acquired company can reliably execute customer-oriented tech.
  • Agility is no longer optional. Some new consumer behaviors might endure, but others will change or emerge. In the current disruption, nimble business models are likely to generate more value in deal negotiations and allow for a smoother integration. Also, if one party in a transaction has a stronger record of being agile, dealmakers should consider how that agility can translate to other areas of the business during the diligence and integrations phases of the transaction.

Regulatory shifts: Privacy and antitrust laws take a different direction

Economic, social and political crises often drive shifts in public policy. For example, the 2007 financial crisis led to broad regulatory changes in the US and globally. This recession is another crisis, and the policy changes potentially in play include privacy and antitrust laws.

The health crisis has led to proposed legislation that would enable more data collection for public safety purposes while still protecting privacy. Slightly more than half of Americans say it would be acceptable for the government to use people’s mobile devices to track the locations of people who tested positive for COVID-19, a Pew Research Center survey in April 2020 found.

But even as citizens increasingly rely on today’s biggest tech companies for work, education, healthcare, entertainment and countless other services amid the health crisis, US lawmakers remain concerned about the dominance of tech giants. These opposing yet intertwined forces will likely complicate and shape debate over antitrust and data privacy rules going forward.

Deal implications

  • Relaxed rules shouldn’t determine privacy practices. COVID-19 has led to less enforcement and waived penalties around privacy in areas such as healthcare, which has seen a rise in telemedicine. But that’s not an excuse for companies to compromise privacy and data protection. Dealmakers need to assess if the parties in a potential transaction have an adequate focus on customer and employee experience and trust and that they’re making serious efforts to uphold privacy-friendly practices. Examples include installing privacy principles in customer loyalty programs and developing formalized employee privacy programs.
  • Big tech’s services shape antitrust laws. The pandemic will likely complicate debate over the scale of tech giants and their market dominance, since technology has played a critical role in managing the spread of the virus while helping businesses stay open. Major antitrust reforms could be difficult in a crisis, but potential acquisitions by big tech companies will continue to be scrutinized. As the economy improves, calls for divestitures could increase. 
  • State and local governments become more active. Before the pandemic, some states and municipalities took their own actions to regulate industries where data was a major part of the business. For example, privacy laws in California and Maine went into effect in 2020. While federal government action may not be imminent, state and local governments — already called into action by COVID-19 — could be more proactive. It will be critical for dealmakers to watch regulations across all levels of government.

Prioritize purpose and inclusion: Dealmakers respond to evolving ESG concerns

Amid nationwide demonstrations for social justice, many are realizing there’s significantly more to be done to end societal systemic racism. This comes as the health crisis exposes health disparities among Black and Latinx communities. In addition, there’s more focus on the threats of climate change to companies and, by proxy, the financial markets.

At the corporate level, shareholder and customer scrutiny of a company’s labor practices, talent management, product safety, risk assessment, crisis response and data security has never been higher, magnified in large part by social media. While the bottom line remains important, executives and boards are increasingly reviewing board diversity, executive pay, business ethics and other elements of ESG.

Private equity firms can also expect to see increased focus from limited partners and potential investors on how they’re addressing these risks in future deals and ongoing investments.  Companies with management practices that consider broader industry, regulatory and societal risks are more likely to drive long-term sustainable performance, shareholder value and greater investment returns.

Deal implications

  • Assess ESG risks and opportunities. Considering the greater focus on evolving risks, due diligence should address material ESG risks, as well as how often a target company has been pressed by investors, customers and other stakeholders to address ESG concerns. Acquirers will also need to evaluate if the target has built ESG considerations into its strategy — whether the investment is for a short-term hold period or long-term ownership. Information on ESG-related risks can both support long-term value creation and minimize the chances of near-term ESG-related exposures that can damage a company’s brand.
  • Form a deeper understanding of workforce diversity and inclusion. Workforce diligence in a deal should go beyond the basics of headcount, payroll and traditional analysis. For acquirers, it’s critical to assess ethnic and gender diversity and inclusion programs at the target company and compare them to their own practices and programs. This is relevant not only for determining the full value of a workforce, but also for developing the M&A integration plan. This diligence should also extend to executive leadership and the board of directors.   
  • Move beyond the branding of “going green.” Environmental regulations vary by country and state and can be a critical compliance risk. Dealmakers are conducting further diligence into a target’s environmental profile and claims to ensure the company is not providing misleading information that its products or services are environmentally sound. Beyond assessing data for emissions, carbon footprint and other climate-related risks and opportunities, dealmakers should go deeper and evaluate raw material sourcing, water usage and other factors. As both customers and investors increasingly focus on the impact of their purchasing decisions — from cars to cleaning products to packaging — dealmakers should consider evaluating environmental impacts along the entire life cycle of a target’s products and services.  

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Colin Wittmer

Colin Wittmer

Deals Leader, PwC US

Curt  Moldenhauer

Curt Moldenhauer

Deals Partner, PwC US

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