The COVID-19 crisis has caused economies to slow and societies to nearly shut down, disrupting companies’ operations and putting millions of people out of work. In fact, many national economies have entered a recession.
History shows that distressed M&A activity rises significantly in the wake of recessions. Data from the past two global recessions shows that distressed M&A activity reached its apex within one to three years after the recessions peaked.
During the global recession in 2001, the number of distressed M&A deals was 710, according to Refinitive. Distressed M&A activity rose the subsequent year, and the number of deals reached 890.
The difference was even more dramatic for the Great Recession. The number of distressed M&A deals in 2007 was only 200, but distressed M&A activity rose during each of the next three years until it peaked in 2010, when the number reached 920 deals.
BCG expects this pattern to repeat itself this time as well. If the global economy reaches its recessionary floor in 2020, we anticipate that distressed M&A activity will rise steeply in 2021. After experiencing significant declines in revenue owing to the COVID-19 crisis, many companies have drawn down their credit lines. With limited access to new financing, a number of these distressed companies will need to use M&A to dispose of certain assets in order to bring in cash and reassure lenders that they are taking decisive actions to shore up their balance sheet.
However, distressed companies face an inescapable dilemma when they pursue M&A. On one hand, they want the process to proceed as quickly as possible in order to retain customers and employees, avoid business disruptions, and conserve cash. On the other hand, companies want to maximize value creation by preparing an equity story and broadening the pool of potential buyers. Companies also want to assure possible bidders of the deal’s value by letting them conduct a thorough due diligence. But all that takes a fair amount of time—typically from 9 to 15 months—and distressed companies may not have enough cash on hand.
Companies can cut this Gordian knot by carving out the healthy part or parts of their business that will generate the most cash in an accelerated time frame.
BCG’s proven approach has helped numerous companies navigate distressed M&A deals, including complex carve-outs, by taking three actions.
Radically Reducing Process Time. There are hundreds of topics to consider when undertaking a carve-out. To accelerate the process, BCG applies its deep industry expertise to identify the topics that represent the biggest risks for buyers and that have the most impact on the value of the deal. Then BCG uses its proprietary playbooks, which detail how to handle the standard components of a distressed M&A carve-out, to help companies address those key topics. Meanwhile, companies can focus on removing potential stumbling blocks to the deal or packaging it in a way that will attract the most interest. In addition, BCG uses a comprehensive suite of digital tools (such as KEY by BCG) to make it quicker to design the carve-out deal and easier to track its progress.
BCG also leverages its longstanding relationships with distressed M&A advisors, insolvency administrators, and other experts to foster collaboration, facilitate agreement, and enable the client to make rapid decisions in distressed M&A situations.
Providing a Due Diligence-Ready Concept. BCG provides a carve-out concept that makes it easier for bidders to perform due diligence. This broadens the bidder universe, improving a company’s chances of executing a distressed M&A deal and lowering the risk of valuation discounts. The concept includes three components:
Making the Carve-Out Operational and Ensuring Business Continuity. Distressed M&A usually involves a high level of uncertainty. Making the carve-out operational reduces or removes this uncertainty. Bidders understand exactly what they will get, and they know that the carved-out entity can hit the ground running. Here are some steps that sellers can take to make the carved-out portion of the business operational on day one:
Facing severe market conditions, a major European wind energy company filed for insolvency in 2019. The company had both manufacturing and service components, but it could not find any bidders for the whole business. The onshore service business attracted several substantial bids, but after the lead bidder nearly dropped out, the company engaged BCG to keep this distressed carve-out deal on track.
Using its deep knowledge of the wind energy industry and working closely with the client, BCG delivered a comprehensive carve-out concept within three weeks. The concept featured a carve-out perimeter designed to minimize both process duration and complexity. For instance, it included full IT functionality to ensure business continuity on day one after the completion of the deal, and to avoid any of the delays involved in disentangling networked systems.
The deal also provided full overhead in terms of finance, human resources, legal, and R&D functionality so that the buyer could continue running the business as a standalone entity without committing to any particular integration path. To make it easy for the bidder to perform due diligence, the carve-out concept included comprehensive data packs on employees, facilities, contracts, and other key assets. The concept also contained a restructuring plan that provided the bidder with guidance and suggestions on how to restructure and run the carve-out business after day one.
BCG helped with the successful execution of the deal by creating an activist project management office to support a variety of transition groups on topics such as employee staffing, organizational design, financial reporting, the transfer of physical assets, the functionality of critical processes (especially order-to-cash and procure-to-pay processes), the availability of critical IT systems, and the transfer of all critical supply chain contracts and materials.
Following a tremendous effort by the client’s organization and project team, and with BCG’s support, the client successfully closed the deal at a favorable valuation and faster than usual. The deal also benefited the client’s creditors and ensured a safe landing place for more than half of its employees.
Companies can boost their chances of successfully carving out a part of their business and closing a deal by following these guidelines:
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