Uncertain times caused by economic downturns or natural disasters often cause companies to go into financial turmoil, which presents a key opportunity for better-endowed firms to acquire other businesses at a lower cost than normal; however, this calls for greater scrutiny of the business’ viability, says law firm CMS RM Partners.
CMS RM Partners director and Africa mergers and acquisitions (M&A) head Deepa Vallabh says business transactions, overall, are down across the South African economy right now, but, she believes there will be an uptick in M&A deals in the medium to longer term.
“This is because there are opportunities in a downturned market to acquire companies at reduced valuations and companies that have experienced short-term depressed activities but still have long-term strong fundamentals become targets ripe for acquisition.
“There have been some deals across Africa in the M&A space in March, which indicates that businesses that have the cash reserves not only continue their own businesses but also expand by actively investigating deals,” she notes.
CMS expects to see M&A deals where the underlying features of the businesses that are being acquired are solid, but the business is facing temporary cash flow issues during the lockdown.
New cash coming by way of acquisitions and increased facilitation on working capital may assist companies to stay afloat after the lockdown.
However, Vallabh highlights that this will need to balance with investor appetite in the market, particularly in the context of a low-growth outlook and difficult macroeconomics in South Africa, which has been exacerbated by the Covid-19 crisis.
She explains that, with the lockdown, there are some challenges to M&As that come to the fore and therefore people should not make quick business decisions, even though there are some decent business opportunities around.
“Thinking that companies can make a ‘quick buck’ and overextending themselves financially is a common mistake during uncertain times. It is also important for buyers to understand what the long-term outlook is for the sector in which you are planning to invest.
“In some downturns, certain sectors never recover, as either a new strategy or some kind of novel innovation is required to keep the companies going.”
Vallabh says if businesses are not in a position to inject cash into a cash-strapped new acquisition, while maintaining their financial position, they are setting themselves up to fail.
Additionally, she adds that buyers of cash-strapped businesses need to ensure that the lack of cash is purely as a result of the lockdown and not the result of fundamental problems with the business model or management.
DOING DUE DILIGENCE
CMS corporate investigations and forensics head Zaakir Mohamed says astute businesses will still have to exercise a degree of care and caution when considering M&A deals.
“If companies want to buy a distressed company right now, they still need to understand what they are buying, do the proper due diligence and ensure that the value proposition makes sense,” he adds.
Mohamed tells Engineering News that sellers will want to push through deals quickly in the current uncertain times to limit their exposure to further lockdown-related problems.
Similarly, buyers might want to ensure they snag a deal before their competitors. This could result in both parties foregoing doing the necessary due diligence and only doing the bare minimum to save time.
This leaves the buyers open to not confirming that the underlying value is, in fact, present in the business that is being acquired. It must be remembered that conducting an effective due diligence ultimately means “doing your homework” and “thinking things through” prior to making a decision.
Mohamed notes that conducting an effective due diligence includes ensuring that the buyer has a full understanding not only of the commercial viability of the business it intends acquiring but also of the risks posed by such a business.
“Conducting a meaningful forensic due diligence as part of the due diligence procedures will ensure that the buyer has a full understanding of what these risks are so that these can be addressed at the time of concluding the relevant transaction.
“For example, by including appropriate indemnities and warranties.”
In the case of multinational organisations that are linked to the US and subject to the US Foreign Corrupt Practices Act, 1977, it will ensure that these organisations also mitigate the risk of successor liability post transaction – being held liable for any bribery violations of a target entity that is purchased, Mohamed explains.
In times of uncertainty, the value of paying closer scrutiny should not be overlooked as this will ultimately protect the buyer in the long run. It is usually when there is urgency or uncertainty that meaningful due diligence procedures tend to be flouted in favour of getting the deal through quickly which can have long-term negative effects for the buyer.
However, Mohamed points out that this is not to say that deals should not go through when such concerns are identified, but it is definitely in the buyer’s interests to know and understand the issues before they conclude the deal to ensure that these can be addressed appropriately.
Mohamed further recommends that, given the current pandemic, buyers ensure they include, as part of the forensic due diligence procedures, conducting meaningful background searches which include adverse media report searches (in terms of which any adverse media reports concerning a target identity is identified) and the like.
While these kinds of searches should inevitably be included in any due diligence exercise, conducting these searches during the current climate are not in any way hindered owing to the lack of mobility and often provide valuable insight into the seller.
The current lack of mobility does pose certain challenges regarding access to information or individuals, for example for interviews, but buyers need to identify appropriate methods of receiving such information and not ignore the procedures completely.