The 2021 outlook for M&A activity – ”Tacking” the headwinds to M&A in 2021
Thoughts from December 2020: As we head into the elevated uncertainty of the New Year, deal-making in 2021 will cut across a risk continuum.
The current macroeconomic environment will inevitably result in more stressed M&A transactions in my view. COVID-19 will give rise to geographic opportunities for overseas buyers, with the UK being a potentially ”doubly- interesting” prospect for some buyers given the dual COVID-19/Brexit headwinds for sterling. In scenarios in which corporates are seeking liquidity, macroeconomic stress will likely precipitate the scale of non-core assets as one of the options in a management team’s ”playbook”.
Exactly when stress becomes distress will remain a grey area, particularly against a backdrop of so many moving parts – lockdowns, fiscal and monetary stimulus, bailouts, rent holidays, rates holidays, the list goes on. That said, there are undoubtedly areas in which more profound structural shifts will be required across businesses in order to get a consensual restructuring underway, necessitating the sell-off of assets to provide that runway of liquidity.
In M&A carve-out situations involving legacy DB pension arrangements, deals cannot happen without providing answers to the pension scheme risks. Multi-employer schemes, where some employers will be exiting the covenant, force a much broader re-appraisal of deal structure. Beyond the challenges of the COVID-19 backdrop, the new UK Pension Schemes Bill will affect the extent to which parties want to and can, do business going forwards.
Too hard box
Anything that makes it harder to do a deal – unless it is really compelling – can consign great ideas, synergies and value accretion to the ‘too-hard box’. For many capital providers, if there is a buying opportunity, the question often asked is whether it is just ”too hard” if there is a pension scheme(s) attached to a business? This is the fundamental question; and with the changing pensions and insolvency legislative and regulatory environments, for many the easy answer could simply be, avoid businesses with DB pension scheme.
Of course, over recent years we have seen tangible examples of pensions transactions preparing the ground for major M&A activity. Last year, the £3.8bn buy-in of Asda pension scheme’s liabilities, secured in anticipation of a full ‘buy-out’, removed key balance sheet risks and simplified the business at a cost significantly below that of the expected future costs of funding internally. Ultimately, Asda’s buy-in has cleared the runway for this year’s transaction, which returned the business to majority UK ownership for the first time in two decades.
One moral of this story – and the good news for UK schemes – is that there are a growing number of options for DB schemes out there to help unlock a corporate transaction. The rise of consolidators and capital-backed journey plans, alongside the traditional insurance market has provided a much broader range of opportunities and access through which schemes and their sponsors can achieve that.
Across the UK, scheme stakeholders – trustees, sponsors, investors, the UK government and their respective advisors – need to recognise the range of solutions that can not only help to enhance the security of members’ benefits, but ultimately unlock M&A and potentially secure long-term value for the underlying business. By establishing the context and defining a focus and set of parameters around how much capital providers and bidders are willing to spend to unlock a transaction, it is possible to achieve a much better outcome for all parties.
Instead of putting companies in the ‘too-hard box’, it is necessary to think creatively about the best structure, assess the options and tools for managing the pensions risk as part of a buyer’s acquisition strategy, which can result in paying less for the business, with the potential for value accretion exit.
One potentially significant, incremental legislative headwind for the outlook for M&A next year will be the new rules giving the UK government a veto on strategically important businesses across a number of sectors. The legislation is intended to protect the UK’s ”strategically important” companies, the transfer or failure of which would be disproportionately harmful to the nation’s economy. Of course, the question remains as to what would happen to the pension schemes of strategically important businesses which find themselves the subject of overtures from foreign bidders.
More broadly, the new Pension Schemes Bill, continued evolution in the superfund regime and a post-Brexit consultation on changes to Solvency II, will add additional complexity to deal-making in 2021, both for capital providers and corporate sponsors. Through the challenges of the current context, getting the right advice and having all tools at your disposal – from origination and structuring through to derisking or consolidation – will be key to ”tacking” the complexities of the current economic backdrop.