Jennifer Fonner Fitchen, Global Co-Lead of M&A Practice & Brent Steele, Partner in M&A and Private Equity Group
By Jarrett Banks
Sidley’s new report, in collaboration with Mergermarket and based on interviews with 150 corporate and private equity professionals: “Creative Deal Structures: Energizing the M&A Market Post-Crisis,” reveals how deal making will evolve as the pandemic recovery continues.
IPO Edge sat down with Brent Steele, Partner in M&A and Private Equity Group and Jennifer Fonner Fitchen, Global Co-Lead of M&A Practice, to find out more.
IPO Edge: What are the key factors dealmakers need to consider as the M&A market continues to recover from the COVID-19 pandemic?
Jennifer: It’s a great question, and one our report, created in collaboration with Mergermarket, looked to answer, in part by surveying 150 professionals from U.S. corporate and private equity firms to see how their views are consistent with, or diverge from, what we at Sidley see in our practice. Consistent with our experience, these professionals resoundingly pointed to the need to be creative in deal making, citing that as the biggest driver of deal making over the next 12 months. Interestingly, more than 60{efe5d79870c08482e17ab0c97855f89429dac5f22c46026d3ca83573faec2208} of respondents who use creative structures say more of their recent deals have incorporated these structures than in the past and nearly half who have not employed creative structures in deals are now actively considering doing so.
We believe that creative deal structures will play a vital role in ensuring that market participants can overcome some of the pandemic-related reservations about M&A. However, there are reservations. When surveyed in November 2020, respondents did not expect U.S. M&A activity to bounce back fully over the next 12 months. Some 90{efe5d79870c08482e17ab0c97855f89429dac5f22c46026d3ca83573faec2208} of respondents expected deal volumes overall to be down from pre-pandemic levels, including 30{efe5d79870c08482e17ab0c97855f89429dac5f22c46026d3ca83573faec2208} who expected them to be down by as much as 25{efe5d79870c08482e17ab0c97855f89429dac5f22c46026d3ca83573faec2208}-50{efe5d79870c08482e17ab0c97855f89429dac5f22c46026d3ca83573faec2208}, with 17{efe5d79870c08482e17ab0c97855f89429dac5f22c46026d3ca83573faec2208} predicting an even greater decline. Just 4{efe5d79870c08482e17ab0c97855f89429dac5f22c46026d3ca83573faec2208} expected M&A volumes to exceed pre-pandemic levels over the next year. This aspect of the survey diverges sharply from Sidley’s experience, and likely the actual performance of the M&A market. Activity for Q4 2020 as a whole ended up exceeding most people’s expectations and, if Sidley’s experience is indicative, Q1 2021 will as well.
It can be argued that creative deal structures have already allowed activity to exceed expectations and we expect that to continue.
IPO Edge: Why are creative deal structures being employed with greater frequency and predicted to continue to increase?
Brent: There is no shortage of deal-making opportunities, given the expectation of an economic recovery, and as businesses restructure for growth or offload distressed assets. Overall, almost three-quarters (72{efe5d79870c08482e17ab0c97855f89429dac5f22c46026d3ca83573faec2208}) of respondents pointed to valuation opportunities. There are also substantial funds available, with dry powder in Private Equity approaching an all-time high.
Notwithstanding perceived valuation opportunities, corporates, which are more frequently buyers, were particularly gloomy in their outlook for expected deal activity, reflecting what we believe is an intention to be well-disciplined on price. Almost a quarter (23{efe5d79870c08482e17ab0c97855f89429dac5f22c46026d3ca83573faec2208}) expected M&A volumes to be at least 50{efe5d79870c08482e17ab0c97855f89429dac5f22c46026d3ca83573faec2208} below pre-pandemic levels over the next 12 months, and none predicted an increase. By contrast, private equity respondents, which may be sellers as frequently as they are buyers, were likelier to anticipate a more modest departure from pre-pandemic activity.
Jennifer: While public equity markets, led by the US, have proved resilient in the face of the COVID-19 crisis, there is a clear view that sellers are being forced to take a more conservative view on both valuations and acceptable deal terms. Indeed, more than half of respondents (52{efe5d79870c08482e17ab0c97855f89429dac5f22c46026d3ca83573faec2208}) foresaw better deal terms for buyers, potentially reversing the trend in recent history towards frothy valuations and other increasingly seller-friendly terms.
With continued uncertainty around the timing of that recovery as we move through, and hopefully past, the pandemic, narrowing of the valuation gap will clearly be an important M&A driver. Creative structures have become increasingly important in bridging the gap between sellers’ (higher) expectations and buyers’ (lower) willingness to pay.
IPO Edge: How do creative deal structures surmount those and other issues?
Jennifer: Different types of creative deal structures can provide the means to surmount issues such as the reservations of risk-averse parties, bridging valuation gaps and providing rapid deployment of capital options for opportunistic dealmakers.
Special purpose acquisition companies (SPACs) provide opportunistic investors with a means to move quickly – as well as to enable private company owners easier access to the public markets. As has been well-documented, 2020 saw a marked increase in the use of SPACs, as investors sought to raise funds ready for rapid deployment as the volatile environment presented opportunities.
Joint ventures, club deals, contingent equity arrangements and similar mechanisms provide ways to pool resources and share the risk. Joint ventures were in fact the most common creative deal structure employed by respondents. A club deal may provide a seller with a route to sale that would otherwise be difficult to secure. Deals involving equity clawbacks or contingent considerations show how even buyers with a defensive view of the M&A market can build protection into transactions.
Brent: Private investment in public equity (PIPE) deals offer several advantages that are particularly relevant in the current environment. Notably, they provide publicly listed businesses a means to raise funds more quickly than traditional transactions would allow, with lower costs and potentially less regulatory complication compared to public offerings. For investors, there is an opportunity to secure a stake in the target company at a discount to the share price.
IPO Edge: What sectors are using or expected to use creative structures the most, and why?
Brent: More than half of respondents in our survey suggested that they are more likely to use creative deal structures in certain industries, and 86{efe5d79870c08482e17ab0c97855f89429dac5f22c46026d3ca83573faec2208} identified the Energy, Mining & Utilities sector as one in which creative structures would be employed. This is not surprising. The energy sector has experienced volatility, including as a result of the pandemic, and it being capital intensive, so many participants in this space are looking to creative deal structures as a way to hedge risk and share costs.
Respondents also believe that creative deal structures are likely to be employed in the Industrials & Chemicals (71{efe5d79870c08482e17ab0c97855f89429dac5f22c46026d3ca83573faec2208}), Pharma Medical & Biotech (52{efe5d79870c08482e17ab0c97855f89429dac5f22c46026d3ca83573faec2208}) and Financial Services (42{efe5d79870c08482e17ab0c97855f89429dac5f22c46026d3ca83573faec2208}) sectors. While there is no universal driver for creative deal structures, we at Sidley have many times seen joint ventures and minority investors used to acquire or develop new technologies and intellectual property, particularly in these segments, and we expect this trend to continue.
IPO Edge: As a primary driver of creative deal structures, what is the outlook on SPAC activity for the rest of 2021?
Jennifer: Respondents expect SPACs to remain prominent over the next 12 months. Again, this is consistent with what we in the M&A and Private Equity practice at Sidley have been seeing. SPACs continue to lead the initial public offering (IPO) market by a wide margin over all other industry sectors, with 248 SPACs completing IPOs (55{efe5d79870c08482e17ab0c97855f89429dac5f22c46026d3ca83573faec2208} of all IPOs) raising over $83 billion (46{efe5d79870c08482e17ab0c97855f89429dac5f22c46026d3ca83573faec2208} of all IPO proceeds) in the U.S. markets in 2020. Sidley was at the forefront of the SPAC boom in 2020, and, with our deep bench of talent representing companies ranging from Porch.com to Cloudbreak, we are seeing this boom continue first-hand and are seeing even more SPACs in 2021.
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John Jannarone, Editor-in-Chief
Twitter: @IPOEdge
