As concerns about a slowing economy persist, public companies, private equity firms and other potential acquirers are weighing adjustments to investment strategies. Compared with previous economic cycles, the amount and diversity of capital available for M&A is greater than ever. 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. Along with sufficient capital, they need to have their house in order—psychologically as well as operationally—to act on buying opportunities as company valuations decline.
How do you position yourself to make acquisitions that could drive long-term growth? A thorough diagnosis before a downturn can reveal specific actions to navigate challenges and exploit opportunities later. Getting ready now allows buyers to act decisively during a period of uncertainty. It also can limit the anxiety that often comes with making aggressive bets in a down economy.
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:
The psychological effect of downturns: A struggling economy 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 can make 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 has 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—would 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.
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.
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 in a slower economy 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 plan for short-term survival 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 are more mobile than before and can quickly end relationships if they experience gaps in key areas.
Strategic and focused cost-cutting: Companies that move earlier on strategic reductions to offset revenue declines can outperform others that wait and sometimes overcompensate, often with indiscriminate, ineffective slashing. Focused cuts should be calibrated to lower volume expectations.
Opportunities to simplify: Prudent reductions can do more than compensate for less revenue. They’ve allowed companies in past downturns to invest in simplifying processes and improve 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 over the past two decades has made the companies that rely on them more vulnerable than in previous recessions. Tension between the US and China is the most prominent example, but other events—such as Brexit and debate over US-Canada-Mexico trade—pose threats to long-standing relationships and processes. 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: The person vs. machine dynamic continues to shift. 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.
Staff cuts save money but 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: Among retained employees, communication during a down economy is crucial. 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 don’t discuss temporary headwinds in the context of a larger, ultimately productive journey miss an opportunity to instill confidence that can spread at the ground level.
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.