Facing up to the new reality: Dealmaking's quick recovery

Rosemary Gallagher hears how dealmaking recovered after the pandemic crisis and lockdown saw many sectors come to a standstill.

How dealmaking made a quick recovery after the pandemic and lockdown saw many sectors grinding to a halt.

The shock occurrences of the first half of this year would have been impossible for any commentators to predict. After getting off to a relatively strong start, Scotland’s deals market – along with those of much of the world– went into lockdown as the Covid-19 pandemic took hold.

Experian’s merger and acquisition (M&A) review for the first half of 2020 noted that Scotland endured a more prolonged lockdown than the rest of the UK. The impact was that Scotland saw the lowest volume of deals recorded for the country in more than a decade. In the first six months, Scotland accounted for 1.9 per cent of all UK deal values and just under 4.1 per cent of deal volumes.

What are the 3 key pillars needed to grow a tech business?

Experian’s analysis shows that a total of 105 deals were announced in the first six months of this year, a decline of almost 73 per cent on the same period of 2019.

Unsurprisingly, deal values fell, dropping 64 per cent from just under £5.6 billion in 2019, to a little less than £2bn for this reporting period. Small cap deals fell by 89 per cent and mid-market deals by more than 50 per cent. “Mega deals” were noticeable by their absence, against the two reported in the same period last year.

Close to 70 per cent of dealmaking in the first half of 2020 was conducted in the first quarter. The full impact of the economic devastation of coronavirus has been felt post-lockdown and into the second quarter.

Why Scotland's deals market is attractive for foreign investors

Turning to deals of the year to date, Experian says that all but two of Scotland’s largest deals were announced post-lockdown. In April, Greencoat UK Wind paid £320 million to acquire South Kyle wind farm, 5km to the east of Dalmellington in Ayrshire. And in early March, just ahead of coronavirus restrictions coming into force, funds managed by Equitix Investment Management agreed to pay £291m in cash to acquire Crail Meters from Glasgow-based Smart Metering Systems (SMS).

The third-largest deal was announced on 25 June and saw Glasgow-based Mitie Group acquire Interserve Facilities Management for just over £271m.

Experian also reports a flurry of fundraisings, both in the capital markets and private equity space, which saw Scottish companies bolster their cash reserves by £443m. Mitie Group raised £201m through a rights issue to ensure a strong financial position and sufficient liquidity to trade through the pandemic. The Restaurant Group, registered in Glasgow, raised £57m to enable it to continue to operate in the challenging environment.

The review describes M&A activity across all sectors as “predictably subdued”, with financial services, usually the most active sector, the hardest hit with a 95 per cent decline in the volume of announced deals – just 13, compared with 249 the previous year.

How family businesses are battling the Covid recession

Infocomms and support services enjoyed an upturn in both the ­volume and value of deals, but valuations were hard hit in the manufacturing, wholesale and retail and financial services sectors with, on average, an 85 per cent decline in comparison with 2019.

Where detailed funding arrangements were disclosed, private equity-backed deals represented just under 29 per cent of the total volume of deals in the first half of the year, against 8.5 per cent in the same period last year. Just 6 per cent of deals were known to have secured debt funding.

Neil Burgess, corporate partner at leading law firm Brodies, says: “The deals market is not detached from the reality of what has been happening in people’s lives. The pandemic has had a devastating personal and financial impact on people and their livelihoods, and there is no doubt it’s also one of the toughest challenges our business environment has faced for some time.”

He adds: “The deals market supports businesses that fuel the economy and prosperity. It’s not immune from the impact of the pandemic.”

Looking at the deals market in the first half of this year, Burgess describes it as “really a game of two quarters” – ie, pre- and post-lockdown. He says the first quarter was strong, but Q2 saw an unsurprisingly abrupt reduction in deal volumes.

Brodies advises business resilience in turbulent times

He says: “As equity and debt markets faltered, the focus has been on liquidity and shoring up balance sheets. This marked dip in Q2 was not unique to Scotland as there was a similar picture across the UK and, indeed, globally.”

But deals have still been getting done across a range of sectors, with Burgess pointing to a few themes emerging over the period.

He says: “Refinancings and ­fundraisings are now quite prevalent. Companies are looking to ­bolster their cash reserves, trying to ensure they can trade through the pandemic. They have been turning to public and capital markets. And private equity has stepped up with a number of further funding rounds for their portfolio companies, which is particularly important for the SME market.”

Burgess says that Brodies has been involved in some significant fundraising work. He gives the example of Alva-based medical products firm Omega Diagnostics, which landed part of a

contract to manufacture Covid-19 antibody tests. The company raised £11m on AIM on the back of that opportunity. “That illustrates

that the public markets are open for the right things,” he says.

Burgess adds that public sector and government agency funding and support has been widely available, with Scottish Enterprise and the Scottish Investment Bank being

particularly active in the market. Notably, SIB, alongside Maven VCTs, supported the MBO and growth of award-winning cyber security business Quorum Cyber Security.

Brodies has also been working on joint ventures, partnerships and solvent restructuring and rationalisation, as many firms and groups take the opportunity to “share some risk” or “do some housekeeping”.

Activity has also continued in certain sectors as those with firepower see opportunities. The law firm handled the sale by Lorimer Care Homes of a portfolio of its facilities to Sanctuary Group at the start of the year.

Burgess says: “Smaller operators in the care home sector are grappling with the challenges of an increasing regulatory burden. That will be exacerbated by the current situation. Bigger players will continue to act as consolidators.”

He describes food and drink as a stalwart sector still attracting interest from overseas buyers, with market prospects remaining positive in sectors such as technology, fintech, business support services, cleantech and healthcare.

Looking ahead, Burgess says: “We have to acknowledge that the economic outlook for the foreseeable future undoubtedly remains uncertain and testing. But there is some cause for optimism around a gradual upturn in deal activity.

“I think the market will adapt and evolve. Scottish business tends to adopt quite a resolute attitude. As vaccine research continues and we wrestle with the realities of a post-Covid-19 world, and the challenges of Brexit to come, this attitude will stand the market in good stead.”

Callum Gray, director and head of deal origination, corporate finance, at chartered accountants and business advisers Anderson Anderson & Brown, is also relatively optimistic about the deals market, despite the undoubted impact of Covid-19.

He refers to deals now being announced that began during the second half of 2019 and early this year.

Gray says: “Obviously, in Q2 the world turned on its head. But, there were certain deals that lent themselves to being done regardless of Covid-19 for various strategic reasons, such as succession planning.”

He is hopeful that the deals market is over the worst of the impact of the pandemic and lockdown and that after taking stock businesses are now becoming more active.

“We’re working on various mandates where strategic and acquisitive groups have said, ‘We are through this, we understand where our own business is at and are ready to proactively pursue opportunities’,” Gray continues. “That momentum is expected to continue to ramp up as the year goes on and into 2021.”

He gives the example of Inverness-headquartered investment group Envoy and Partners, which has completed four transactions in the last couple of months because they were quick at getting though any internal reviews.

But Gray points to lasting impacts of the Covid-19 crisis, including its effect on price expectations. He says: “Looking at themes, for certain sectors, the recent conditions might highlight some noteworthy characteristics for acquirers in assessing how potential targets have reacted to change. Was it the case that the owner was the business and has been hands-on in ensuring its survival? Or has the management team and the systems and processes in place been able to survive and withstand the pressures and challenges?

“Covid has stress-tested most businesses. Have they been able to respond and react or have they struggled more, compared with their peers?”

In terms of the types of deals getting done, Gray says that during the pandemic some strategic acquirers have realised that they are missing certain services which they now want to bolt on. Succession planning is also taking place, and management incentive schemes to reward executives for getting the business through tough times.

He says: “A lot of businesses are looking to strengthen their balance sheets. Now might be the right time to get a more affordable finance package or take on growth funding.”

Gray says that in terms of who is writing the cheques for various deals, the Scottish Investment Bank is a high-profile player, particularly in the technology sector where it has partnered up with private equity businesses.

Money is also available from private individuals, and specialist investors also have a role to play in the dealmaking future.