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Beyond the pandemic: the future of M&A

Macro focus: predicting the unpredictable

Predicting the economic impact of a pandemic is notoriously hard to do. Forecasts made during the SARS outbreak in 2003 put its eventual cost at between $30bn and $100bn, and suggested the global economy would take two years to recover. In reality the outbreak had a negative impact on GDP in just three territories and curtailed economic growth in only five.

COVID-19 is an order of magnitude larger than SARS, indeed than any public health crisis in the past 100 years. Assessing even its current economic impact is fiendishly difficult because one of the consequences of lockdown restrictions has been to hamper the ability of national statistical agencies to collect data. However, a recent paper from the San Francisco Federal Reserve offers clues to its potential longer-term effects.

The study analysed 15 similar events over the past millennium and found they are typically followed by a long period of suppressed interest rates and increased levels of personal saving. If a vaccine is found quickly then all bets are off. But if not, and COVID-19 follows the pattern of previous health crises, the current fall in individual spending could be sustained. For a global economy that for decades has been driven by consumer behaviour – with a strong globalist/international mindset – we could be about to enter very choppy waters.

It is not just personal wealth and spending that will need rebuilding. Companies in sectors from bricks-and-mortar retail to oil and gas have had the rug pulled from under them by the sharpest drop in demand the world has ever seen. We have already entered a period of reckoning marked by a wave of consolidations and portfolio and balance sheet restructurings. But once this has passed we are likely to see many surviving businesses maintaining bigger cash buffers rather than entering into deals, despite research from McKinsey showing companies bold enough continue executing 'meaningful' acquisitions during the last downturn outperformed their less acquisitive peers by a factor of six. Dividends may also remain heavily constrained and share buybacks are likely to be rare, adding to the vicious cycle. In this scenario a large swathe of the global economy could be about to experience what Japan has lived through since the 1990s, where many businesses are cash-rich but their growth is curtailed by caution.

Virus acts as a deal accelerator – and a brake

At the same time some businesses have got stronger through the pandemic, not least the tech giants and innovators that have kept the world connected and the pharma companies that have had early success in supplying COVID-19 therapies. Likewise, those that operate online – outside hard-hit sectors such as travel – have proved among the most resilient. According to Microsoft CEO Satya Nadella, the pandemic has driven ‘two years of digital adoption in two months’, a development that will only accelerate the need for technological innovation and acquisitions to drive business model transformation. We believe logistics and warehousing assets will come into play as companies look to fortify (and potentially shorten) their supply chains. And, longer term, the crisis is set to further intensify interest in 5G as the world adjusts to a future in which many workers may not quickly return to ‘normal’ office life – if at all.

Barriers to FDI grow

But while COVID-19 can, in certain circumstances and verticals, act as a driver of deals, it is also boosting some of the forces that weigh on them. Since the earliest days of lockdown, governments have been scrambling to protect domestic companies left weakened by the crisis. Spain has suspended plans to liberalise its foreign investment regime; Australia reduced to zero the value threshold at which it can call in deals for review; Japan has further tightened its rules; and India has become embroiled in a spat with China after announcing business from neighbouring countries would need to seek government approval for any inbound investments.

As the geopolitical rhetoric heats up over who’s to blame for the virus, the barriers to FDI (which had been growing even before COVID-19) are likely to get bigger still before they recede. Potential buyers might need to consider carefully their ‘nationality’ in the eyes of some regulators – a point that is particularly acute for international financial sponsors with limited partners and investors spread across the globe.

More assets deemed critical to national resilience

The crisis has also caused governments to re-evaluate which assets will be critical to national security in the future. Regulators and politicians may choose this moment to push for the broadest possible interpretation of the term as they look to protect their economies, potentially taking us back to the days of ‘strategic yoghurt’ – when Pepsi was blocked by the French government from acquiring Danone – or worse.

The Committee on Foreign Investment in the United States (CFIUS) has always been able to examine controlling investments in the health sector. But recent rule changes give it the power to do likewise for certain non-controlling investments where the US business is involved in particular export-controlled technologies or collects large amounts of health data. Post-COVID, scrutiny of investments across a broader swathe of healthcare assets – from vaccines to medical equipment and protective gear - is likely to increase amid the scramble to build more resilient supply chains. And this is not a phenomenon limited to the US: at the end of March, the European Commission published guidance calling on all member states to be vigilant in the face of foreign bids for healthcare capacity and related industries such as R&D.

Is a paradigm shift under way?

It’s also possible COVID-19 could be a catalyst for more fundamental economic and social change. The speed at which the coronavirus caused unemployment to spike in advanced economies – and the sheer number of businesses that have required emergency financial support – have laid bare the fragility of our current economic system. Likewise, the reported spread from animals to humans of a new and deadly pathogen offers further evidence of just how delicate our relationship with the environment has become. It is no surprise then that influential leaders are calling for post-COVID stimulus money to be used to drive a greener recovery. Taken together with numerous examples of businesses doubling down on their social impact commitments in the teeth of a downturn, there are signs a paradigm shift is upon us. If society does indeed reward companies that behave ethically during the crisis and beyond, the impact on investment flows, asset prices and deal-making could be profound.

If you are interested in discussing any of the themes in this report, please reach out to your usual Freshfields contact. For more insights on the current and future impacts of COVID-19, visit our coronavirus hub