Is it the best of times? Or is it the worst of times? The answer, according to Kathleen McCann, executive chairman of United Road Services and executive partner at Nonantum Capital Partners, is both.
That mixed economic reality is creating opportunities for strong companies to be acquisitive, and leading companies fiscally weakened by the pandemic’s uneven impact on markets to look over their collective shoulder. That’s in part because dealmakers are on the hunt for troubled companies to snatch up at attractive prices, smelling blood in the proverbial waters.
But, other than cash still being king, nothing is certain. And that uncertainty, according to McCann, should have concerned companies focused on balance sheet management until the market picture comes into clearer focus.
McCann spoke with Smart Business Dealmakers in late summer about her sense of current and future M&A prospects, and where both opportunities and obstacles may await.
From your vantage points as executive chairman of an operating company and partner at a private equity firm, how do you see the state of the M&A market today, certainly in the midst of this COVID-19 pandemic?
Well, it's really a tale of two cities here, isn't it? We've got some companies that are in really excellent economic condition with strong balance sheets. They're positioning themselves to be aggressive in this marketplace. Then there are other companies that are not doing well and have immediate need of balance sheet repair. The former group is looking for transactions and an opportunity to grow and the latter group is trying desperately not to have to transact.
I think our sense is that M&A is going to be a little sluggish until we have a crossover point of the two. But current momentum would suggest that activity is going to escalate throughout the end of 2020 and certainly into 2021 primarily as lenders push companies to raise capital and improve their liquidity.
So, the short answer is: Expect deal flow to pick up from here through the end of the year and into 2021. I might also add, from the perspective of a recovering CEO, that ensuring financial stability is job one. If or once liquidity is secured there are opportunities out there and it's a prime time to look for them and figure out how to expand and take market share during this. Or at least positioning your company so that once the recovery happens, you're able to take advantage of opportunities.
Where are the deals getting done? Is it sector by sector? Is it more corporate carve-outs or even family businesses who are looking for an exit during these weird times?
I think it's a little bit of everything honestly. We track our investment opportunities in many different ways, but we’re mostly right now seeing troubled companies all different sizes and industries.
Let’s start with the consumer sector. These companies really need their balance sheets fixed and have to raise capital in whatever form and at sometimes whatever valuation they can. The good news for them is that there still is a lot of money on the sidelines, so that's a good thing. Further — because there is that money — it's unlikely that that valuations will dip as much as they probably should considering how much uncertainty there is around growth prospects at this time. By numbers, were next seeing troubled business services entities with bad balance sheets. Corporate carve-outs are certainly out there, primarily from larger companies that are seeking to de-lever. We're also seeing some family and founder businesses that are convinced that it's a good time to be acquisitive, but they need a financial partner to help them take advantage of those opportunities.
What about capital? In the best of times, we know that cash is king. How might balance sheet management and greater liquidity play a more critical role these days in making sure deals get done.
Cash is always, always critical. There's just so much doggone uncertainty out there as to whether or not we're going to have a second wave. What's the shape of the recovery? How does the political landscape impact all of this? But the balance sheet is the backdrop through all of these conversations. You think about it, many companies used working capital to make it through the downturn but now receivables have runoff and as revenues start to return that working capital needs to be replenished. Others have seen their leverage move from a comfortable level — say three, four, five times — to multiples that are significantly higher than that and they just simply need to de-lever. Others are out there and they see tremendous opportunity, but there might be, for whatever reason, usually Justified, a lack of willingness from owners or sponsors or current creditors for whatever reason to increase debt for an acquisition. So, it's a wide range of reasons and activities that are playing out right now. I think on balance lenders have been pretty patient so far trying to work with their portfolio companies, but we'll see later into this fall how long that patience is going to last.
Are there any new roadblocks to closing a deal that have been exposed during COVID that might otherwise not ranked as a red flag earlier?
There are always a lot of roadblocks. The heightened uncertainty as to current and near-term economic conditions is really challenging. Businesses with really great fundamentals may still be in trouble from a cash perspective in 2021 for instance. Buyers have to assess the new normal. So do management teams. Who's got who's got a crystal ball? Another real challenge for us and I'm sure other firms in the middle of transactions, has been the inability to have in-person meetings to assess management teams better. It's just really difficult to get a good sense of team dynamics through a Zoom call or a conference call. So, we're getting there by focusing on companies where we've already met management or have a lot of familiarity with the company or the industry. Or where we can get a very, very high level of conviction through multiple video conferences. But there's nothing like pressing the flesh with somebody, seeing them seeing them eyeball to eyeball. There's just simply going to be more risk on the management side of the equation.
Should those who are looking to raise capital refocus their efforts away from what would have been traditional fundamentals? And during that cap raise is there somewhere else they should be focusing?
It's a really good question. And again, I'm going to go back to the to that period of uncertainty here influencing maybe the answer. There just aren't enough folks that are honestly focusing on the long-lasting impact of the pandemic and how customer behavior might change for their company's products or services.
We hear people throw around phrases like, “It'll never be like it was.” But I'm not so sure that that everybody's really taking that to heart. People want to assume that there will be no change in the relationship with the customers that they have and that simply won't be the case for most. Leaders are also going to have to be very clear about their readiness and their plans to address a shifting marketplace. Think digital transformation. Regulatory impact. What does distancing do? The fact that travel has decreased as much as it has. There are a lot of changes and there’s likely to be permanent residual, if not transformational, change.
What opportunities have been created for the end of 2020 and into 2021 as it relates to M&A?
I think, by my own lights, there are a lot of really strong management teams out there running companies with great promise that — through no or little fault of their own — find themselves with a bad balance sheet. They're just going to need a capital infusion, not only to survive but ultimately to thrive. Fortunately for them, there is a lot of money available to invest right now. But it's not just about money of course. Sellers have choices too. It's about the people and the culture and how things come together. At Nonantum, for instance, we work really hard to make sure that companies that we’re prospecting consider us a partner of choice for the management teams or their families, founders, what have you. So that when they have that opportunity that requires capital, that they choose us to be that partner or to provide that capital. This requires a team that's invested in collaboration and patient listening and a culture of respect for the executives that actually run the companies, do the heavy lifting.
Nonantum’s structure is such that we've got these executive partners, ex-CEOs, who've actually been in the trenches and executed on a daily basis. They're able to offer both the empathy and constructive advice that can be a force multiplier for a CEO.
I think having that practical experience is not only creating opportunities on the buy side, but in the decision-making on the sell side as well.