The pandemic caused by the Covid-19 and the declared lockdown has resulted in an unprecedented worldwide sudden decline in economic activity. It is still early to assess its medium and long term effects on consumer behavior and trends and business activity as it depends on how long the lockdown persists and more importantly how long it takes to find an effective treatment and/or a vaccine against it. However, we will try to assess the short term impact of this healthcare crisis on corporate finance activity, more specifically, on M&A and debt restructurings.
Given the huge impact of the abrupt and unforeseen demand shock, strategic and institutional buyers (i.e. private equity funds) are still measuring its effects on their business portfolios and applying damage controls. At the same time, the tremendous market volatility and uncertainty about the extent of this crisis, precludes buyers and sellers from making transactions. But, even if buyers were willing to bid for a company, they would still have to deal with tightened credit markets (banks actually dealing with existing lenders to avoid defaults) and different price expectations from sellers, most probably reluctant to sell at current prices. Consequently, M&A transactions have reduced dramatically.
However, as soon as uncertainty drops, we should expect private equity funds to be the first to step in, focusing in developed markets. They have a lot of dry powder to invest (estimated at $800 billion; Blackstone alone has $150 bn), taking advantage of lower prices and enjoying less competition from strategic buyers which will prioritize building up their cash balances again.
When analyzing target companies, these funds will certainly incorporate in their assessment the ability of the company to weather unpredictable disruptions in global markets affecting demand or its supply chain.
The global COVID-19 pandemic has placed an unprecedented stress on the ability of businesses to service their debt and obligations, including paying salaries, rents and taxes. Although governments, especially those in developed countries, have granted some flexibility through aid packages, this may not prove to be enough. Moreover, certain businesses—such as oil and gas, airlines, cruise lines, hospitality, brick-and-mortar retailers, and small businesses generally—are being hit harder by the pandemic than others. Although most businesses are expected to return to a normal pace once the uncertainty of this pandemic has subsided, many others will not make it. Nevertheless, many of these surviving businesses need some form of relief on their debt obligations in order to avoid triggering defaults, foreclosures and collection activity during this extraordinary period of economic inactivity. This is even more problematic in countries with underdeveloped capital markets where companies have most of their debt maturities concentrated in the short term. Thus, debt renegotiations are inevitable and may not only include forbearance periods or maturity extensions, but haircuts as well.
Banks should be willing to work with borrowers to avoid foreclosures as they rarely want to take over businesses. It is also worth mentioning the role that private debt funds could play in this crisis, especially in developed markets. They may seek out opportunities to provide bridge financing with an attractive risk/return profile (more costly for companies), and may also engage in convertible loans, which seek control over companies in distress. These funds have deep experience in dealing with distressed debt and special situations.
A basic condition for a successful debt restructuring is to have a sound business proposition that should generate enough resources to pay down debt. If the company reached this situation exclusively because of the pandemic, then in general, unless its demand is negatively affected by a substantial change in consumer behavior, it should be able to honor most of its debt once the lockdown is raised.
When facing restructuring, companies will need to decide between going for a private restructuring or filing a Chapter 11. The former could be much faster and flexible when dealing with a group of homogeneous creditors, usually financial ones, which own most of the debt. However, holdouts may want to take advantage by blocking the transaction. Filing for Chapter 11 implies facing a more regulated and lengthy process, ruled by a judge, but with the advantage that there is no interest accrual for unsecured debt during the process and that once the proposal is accepted by a certain majority of creditors (two thirds in the case of Argentina) it becomes applicable for all creditors. The judge may impose limitations in managing the business and the process may end up in bankruptcy if an agreement is not reached or if the company is not able to face its obligations in the future.
As a conclusion, M&A activity has stalled but should pick up as soon as uncertainty drops, mainly driven but private equity funds. At the same time, we should expect a huge wave of debt restructurings as companies need to rebuild their working capital while facing debt maturities.
Juan Martín Monge – Socio de Finanzas Corporativas Auren Argentina