M&A, in the midst of a crisis, can be deployed to boost growth

The benefits of such deals during upmarket periods are augmented by additional advantages seen during downturns - these include diminished valuations and low interest rates.

MEASURES put in place to contain the spread of Covid-19 have resulted in significant operational disruptions for many companies. Staff under quarantine, interruptions in supply chains around the globe, and a sudden fall in demand from customers have created unanticipated pressure on working capital lines and liquidity.

Against this backdrop, companies have scrambled to cut costs and to try and salvage their existing businesses, as opposed to considering mergers and acquisitions (M&As).

This thinking is actively reflected in both global M&A volume, which fell by 23 per cent in the first half of 2020, and in the total value of deals announced during the period, which was 53 per cent below the first half of 2019.

That said, there have been strong arguments proffered for M&A during a crisis.

A Harvard Business Review study found, in relation to the 2007-2009 Global Financial Crisis (GFC), that "companies that made significant acquisitions during an economic downturn outperform those that did not".

Benefits of mergers include economies of scale, enhanced revenues, lowered costs through operational efficiencies and diversification by expanding business lines and geographic reach.

For instance, Heineken's acquisition of brewery Scottish and Newcastle, in the midst of the GFC, expanded their geographical reach into the United Kingdom and paved the way for a new business line that now boasts over 2,500 pubs across the country. Thomson's acquisition of Reuters resulted in considerable cost savings of close to US$500 million within three months of completion. The benefits of M&A also extend to the post-crisis period - in the aftermath of the GFC, several notable acquisitions occurred, including the purchases of Cadbury by Kraft and of Genzyme by drug maker Sanofi.

We seem to be witnessing a recurrence of what occurred during the GFC - this is evident in that although the initial dip in M&A activity in 2020 was more pronounced than that seen during the GFC, there has been a resurgence with more megadeals (M&A deals valued at US$5 billion or more) in the third quarter of 2020, than the entire first half of the same year.

Consider the following two megadeals that were announced in the fourth quarter of 2020:

(1) ConocoPhillips and Concho Resources - a calculated merger

In October 2020, ConocoPhillips and Concho Resources announced that they had entered into an agreement for ConocoPhillips to acquire Concho Resources in an all-stock transaction valued at US$9.7 billion. This represents a pivot in strategy for ConocoPhillips, which had in recent years "reduced its size and prioritised share buybacks and dividends over growth".

However, given the lower fuel prices and demand caused by Covid-19, ConocoPhillips was likely persuaded by the need to consolidate, and the value proposition of acquiring Concho Resources at a low premium as compared to during an upmarket cycle facilitated the transaction.

Analysts were generally in favour of the merger which was purported to bring US$500 million in annual cost and capital savings by 2022, citing Concho's relatively low debt ratio and its intimate knowledge of the Permian basin which would boost ConocoPhillips's portfolio considering it currently lags behind rivals in this particular sector.

(2) Salesforce and Slack - an opportunistic acquisition

On the other hand, however, analysts saw Salesforce's announcement of its acquisition of Slack for US$27.7 billion as being devoid of logic. Nonetheless, when viewed in terms of Salesforce's history with Slack, overall strategy and timing of its previous and current acquisitions, there is, ironically, long-term potential upside.

In today's pandemic environment with telecommuting work arrangements becoming the norm, Salesforce's aim in acquiring Slack is to provide a "unified platform for connecting employees, customers and partners with each other and the apps they use every day, all within their existing workflows".

Furthermore, while Slack is being acquired for a whopping 26x forward sales, Salesforce has historically made several large acquisitions - it acquired Mulesoft in 2018 for US$6.5 billion, at an enterprise value-to-revenue multiple of 15.8, and it bought Tableau in 2019 for US$15.3 billion, at 11.2x of Tableau's last 12 months' revenue.

Moreover, Salesforce was one of Slack's earliest partners, hence it is likely that Salesforce had ample time to evaluate its integration and synergies with Slack. Lastly, the timing of this deal at end-2020 makes commercial sense in light of the current low interest rates set by the Federal Reserve.

Salesforce's acquisition of Slack may be characteristic of a purchase that is in line with Salesforce's broader growth strategy. Seen in this light, this merger was not driven by depressed valuations but rather, an opportunity that would otherwise be untenable in an upmarket cycle.

Much like the rest of the world, Singapore saw fewer M&A deals during the coronavirus-induced recession last year. Duff & Phelps reported that between December 2019 and November 2020, there were 482 M&A deals in Singapore, valued at US$59.2 billion, compared with US$72.4 billion during the same period a year earlier.

There was also substantial consolidation, especially in the real estate sector which contributed to about 38 per cent of M&A value.

One merger in the pipeline is that between Cathay and Golden Village. Media company mm2 Asia, which owns eight cinemas under the Cathay brand, has entered into a heads of agreement for the possible merger of its cinema business with Orange Sky Golden Harvest Entertainment, which owns the Golden Village cinemas in Singapore. This move would make the combined business the largest cinema operator in Singapore.

From January 2020 to June 2020, Golden Village Singapore's cinema business revenue fell from HK$401 million (S$69 million) to HK$137.4 million compared to the same period a year earlier.

Meanwhile, mm2 Asia, which runs eight Cathay cinemas in Singapore and 14 in Malaysia, saw an 83 per cent year-on-year fall in revenue, an unsurprising outcome as cinemas were closed for nearly four months due to the pandemic.

Furthermore, even after being allowed to open, cinemas are not allowed to operate at full capacity due to stringent safe-distancing measures.

In comparing the two megadeals with the possibility of a Cathay-Golden Village merger, the latter seems more akin to the ConocoPhillips-Concho acquisition than the Salesforce-Slack deal because the anticipated merger of the cinema operators appears to be a necessary and not an opportunistic one, in light of the impact of Covid-19 on an industry already disrupted by content streaming platforms.

The benefits of M&A during upmarket periods (such as economies of scale and enhanced revenues) are augmented by additional benefits observed during downturns like the GFC and the current, unabating Covid crisis, including diminished valuations and low interest rates.

Therefore, businesses should capitalise on the current pandemic climate and consider how M&A, whether for necessary or opportunistic reasons, can be deployed to help them achieve further business growth.

  • The writer is partner of corporate practice at Oon & Bazul LLP.