M&A activity as the world emerges from lockdown

Updated: Mar 22

More transaction activity expected in South Africa

Leading transactions

Business leaders in South Africa (and globally) are emerging from a long COVID-induced hiatus of corporate decision-making. This is leading to a flurry of deal announcements, which are likely to continue for the next 18 to 24 months. In addition, deals shelved in 2020 are back on the table and transaction advisors like us are working on various new ideas and structures to accommodate client requirements for capitalizing on the ‘new normal’ - an environment characterized by vastly different fundamentals from what started 2020. In this essay we explore the volume and type of transactions we see happening in the near term and why this occurring.


The beginning of 2021 saw an 83% year-on-year increase in the sub-Saharan region’s inbound deals to US$1.8 billion, while outbound deals saw a 66% year-on-year decrease to US$721.4 million. This is a stark contrast to the 39% decrease of inbound deals to the sub-Saharan region in 2020. South Africa remains a strong player in the African M&A market and unmistakably dominant in the sub-Saharan market, accounting for 72% of all sub-Saharan African transaction advisory fees generated in first quarter of 2021. The strength of our corporate institutions and relative sophistication of our financial system should continue to be key driving factors of South Africa’s prominence in the African M&A market.


Our projections for M&A activity in the next 24 months

The number and size of transactions being announced by listed companies has already improved on a dire 2020. Foreign investors are taking note of JSE listed companies, particularly given the historically low valuation multiples attributed to such companies. For example, EBITDA multiples globally hover around 20 time, compared to 10 in South Africa. Even with current, political and interest rate differentials, this still leaves gaping opportunities for astute dealmakers. In addition to an uptick in transaction activity in listed companies, private company transaction activity is heating up – due in large part to firming macro fundamentals and some specific industry factors which we highlight below.


Macro fundamentals driving transaction activity

South Africa’s ‘lower for longer’ interest rate policy adopted by the SARB has fundamentally changed the viability and thus attractiveness of using debt to fund transactions. The common perception that valuation numbers will decrease in absolute terms often misses a key principle of valuation – that the value of a company is the present value, discounted at an appropriate hurdle rate, of all future expected cashflows. Mathematically, this means that a decreased hurdle rate will result in a higher value placed on a business (all else being equal). Hence, a higher level of investment today is required to produce the same expected cashflows in the future. What this does for businesses however is make debt financing more appealing, as the cost of equity increases and the cost of debt decreases.


The recent upswing in commodities, and the positive impact on the Rand, will also facilitate a more stable outlook for the economy from an imported inflation perspective. This will improve the likelihood for transaction activity as decision makers feel comfortable in predicting cash flows for a longer period. All of this improves business confidence causing decision makers to be willing to take a view on the future.


Sectors likely to experience the greatest deal activity and factors driving these deals

Our research has seen a marked uptick in transaction activity, specifically in the following three areas:

1. High growth businesses hungry for capital

Capital-intensive sectors underpinned by positive market fundamentals, such as mining and resource-based businesses, are expected to provide a boost to transaction activity in the next two years. Supply shortfalls in 2020 boosted commodity prices and increased the cash reserves of the mining industry. According to recent commentary by Bank of America, the urge to replace reserves will be a big driving force for M&A activity, particularly among gold mining companies. With stability in the regulatory framework, it remains likely that transaction activity will continue to be led by this sector.


2. New ventures looking to expand market reach

Fast growing new ventures seeking expansion capital are announcing funding rounds in a part of the economy that is starting to resemble Silicon Valley in many respects. The swathe of 12J registered Venture Capital Companies has prompted several new ventures, particularly in the technology sector. We expect this area of the economy to undertake more transactions despite the recent announcement that 12J tax incentives will be discontinued. Many of the existing funds are sitting on large capital balances with a mandate to invest leading to a ‘sellers’ market’ as savvy entrepreneurs mop up available capital.


3. Companies in need of fresh capital and critical mass

The pandemic has exposed many businesses in ways unimagined just 18 months ago. Who would have predicted that Comair would no longer be with us>? COVID has dramatically reduced cash holdings in almost all non-commodity industries. This will invariably make the return to financial health a more difficult process. In addition to making the most of covid-relief funds, private firms are investigating broader collaboration opportunities to better prepare for a post-covid recovery. Many organisations have downscaled to such an extent that they will have to merge or be absorbed by rivals if they are to remain a going concern.


The opportunity to merge businesses has fallen out of favour in recent times, partly due to growing economies, but also due to failures in governance processes to satisfactorily reduce risk. However, market conditions and better transaction strategy is resulting in this option being revisited. We are assisting clients with merger considerations and maintain that post-pandemic may be characterised by such transactions.


The role M&A will play in helping businesses adapt to the new post-pandemic normal

Corporate activity (M&A) is likely to experience as upswing in the coming 24 months due in large part to low interest rates and an improving outlook on the recovery. Furthermore, the pandemic has pushed businesses to make decisions and changes now instead of waiting. The age old saying of not allowing a good crisis to go to waste comes to mind. M&A is likely to play a key part in how businesses achieve their objective to emerge stronger and more resilient from this pandemic. We consider this broadly positive for the economy but we caution that post-transaction work will prove if such transactions were justified in the first place.


Expectations in terms of outbound and inbound deal activity

There is a lot of capital chasing relatively few deals at the moment so one can expect some healthy valuations being announced. This was recently borne out by the increased offer made by Huge for technology business Adapt IT.


Conclusion

COVID has certainly delayed many transactions which were close to completion in 2020, and put others on hold entirely, but there has been a clear resurgence in transaction-based activity in the first part of 2021. Although vaccine passports and ‘work from home’ will forever change how transactions are undertaken, the wheels are beginning to turn again and corporate decisionmakers are moving past the all-hands-on-deck emergency measures and restarting projects that have been on pause for the better portion of a year.


We remain optimistic about the size, volume and breadth of transactions taking place in South Africa and broadly across the continent in general. Whilst economic variable such as lower interest rates, stable currency and improved consumer confidence will all promote this likelihood, the ability to manage specific transaction risks will determine if value if created through such activity.


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