Hard brakes being pressed on M&A with COVID-19 overhang

Mergers and acquisitions in the government market were carrying on in the almost-complete first quarter at the same pace that recent years have seen in line with budget growth and overall economic optimism.

In 2019, the market saw 119 deals close. 

Fast-forward to today and the emerging economic pinch due to the coronavirus pandemic and efforts to slow it down have put hard brakes on both the federal market’s own and the overall M&A environment, investment bankers said Thursday during a webinar hosted by law firm Pillsbury Winthrop Shaw Pittman.

The word “uncertainty” may be an easy cliche to fall back on in describing the current situation but also is impossible to avoid, based on how Houlihan Lokey’s Greg Van Beuren put it.

“It’s like asking somebody in the middle of a tornado which direction they’re going. Nobody knows or really has any idea at the moment where we’re headed and for how long,” said Van Beuren, managing director for Houlihan Lokey’s aerospace, defense and government services group.

One certainty at least in the immediate term is that the credit markets have come to a screeching halt around the world and debt is harder to find, plus more expensive. Van Beuren said that for the most part, no new credit is available for strategic activities such as acquisition. If credit is available, it goes right to the balance sheet.

“The real question when it comes to the debt and equity markets is will this be a V-shaped return or a U shape or a prolonged U shape,” he said. “If it’s a V shape, all of this conversation we’re having may be moot in just a few months.”

That lack of available credit stands to freeze out, at least in the short term, private equity buyers that rely on the debt markets to finance acquisitions. Even though many of the GovCon sector’s most notable private equity investors have raised record funds within the past two years, while the overall PE ecosystem is sitting on $2 trillion in so-called “dry powder” funds -- more than ever waiting to be spent.

So are any deals getting done in the federal market given the overall economic climate?

Bob Kipps, co-founder and managing director at investment bank KippsDeSanto & Co., said that the ongoing market volatility has reduced the number of government market deal announcements to one or two per week and that will likely continue during the economic uncertainty.

Much of those are transactions already close to completion and are moving ahead, but the final stretch in advancing them is getting prolonged. Those deals fall in one of three categories, or “rings” as Kipps put it.

The center ring sees corporate and private equity buyers focusing internally to stabilize their business, employees, supply chain and financing. Next are the deals near the finish line.

“Remote confirmatory due diligence, which is that last phase is a little harder, and likely slower than before given the new operating environment and will in the short term crowd out lots of outer ring activities,” Kipps said in reference to the current status of nearly all people working from home. “While most buyers are saying they will look at new opportunities, some have been very honest in saying they are standing down.”

Where one is in the due diligence process also matters given the volatile environment, said The McLean Group’s Cameron Hamilton.

Hamilton, senior managing director who focuses on federal contractors, said it is better for clients at this point in time to be early in the process than right before closing. The deals that do go ahead also depend on where one is positioned even within the GovCon sector itself.

“Are you in some (intelligence) communities or some health care parts of the equation that are seeing almost increased demand trying to keep their folks declared essential keep them on mission on task, or are you in some places where folks are kind of shutting down and holding off until we get through things,” Hamilton added.

Joel Kallett, managing director at business services and technology-focused investment bank Clearsight Advisors, believes that shifts in how companies plan and operate their business does not necessarily mean the M&A market will also change in conjunction.

“That M&A ecosystem in terms of deals happening and values happening will return to normal,” Kallett said. “The way we make the sausage, the way due diligence happens, the way we prepare management meetings, I do think that will be very different in the future than it has been in the past.”