We think 2021 will be a good year for dealmakers. There are significant amounts of private capital to invest, many corporates have strong balance sheets, and banks appear to be in good shape having implemented important changes after the global financial crisis. The rollout of vaccines will be challenging for ethical, health and political reasons, though one of the many positives of it will be helping to revive consumer demand in sectors that were amongst the hardest hit by the pandemic.
The nature and extent of deal activity changed in 2020, though data shows that deals broadly kept pace with previous. Yes, the number and value of deals slowed in the early phases of the pandemic, but this was not a repeat of the global financial crisis, and activity picked-up in the second half of the year. The availability of capital and the stability of financial markets enabled corporates and investors to pursue acquisitions that appealed to them, while the challenge of lockdown immobility was adapted to with more ease than people expected. It turns out that you can value a company, work with advisors, and close a multibillion dollar deal from your living room.
That said, our RiskMap coverage shows that dealmakers need to have a range of issues in mind as they consider transactions in 2021. We point to three of them here.
Firstly, sustainability and environmental policies will be a priority for most governments over the coming years. The pandemic and public opinion have focused minds on the need for more rigorous approaches to the climate and environmental damage. Governments will implement changes that fundamentally shift the nature of demand and supply for different goods and services, and certain practices and products will be regulated out of existence. Investors’ and consumers’ norms and preferences towards certain sectors and industries, products and services, and business practices, are also changing. Taken together, this increases the prospects of investors being left with stranded assets when they approach sales and exits, or being left with a much more limited range of buyers, perhaps also offering lower prices than were anticipated on purchase a few years earlier. Buyers make acquisitions with an underlying thesis about a target sale price and a strategy for how that will be achieved. This thesis needs to be informed by a clear-eyed evaluation of governments’ agendas towards sustainability and the environment, and their associated intent and capability to implement these agendas. Political and regulatory due diligence is going to be an ever more important part of the investment process.
Secondly, regulation will also complicate deal execution. Governments seem more worried than ever about the relationship between their countries’ national security, and the access that corporates and investors (particularly those linked to governments) can have to personal data, emerging technology and important assets. This sensitivity is by no means new. International trade and investment are part and parcel of geopolitics and national security. However, the unprecedented slew of new foreign investment screening regulations over the course of 2020 show that governments are formalising and codifying their intent and capability to scrutinise, intervene in, and dictate whether and how a deal happens. Governments are at pains to emphasise that these regulations are not a symptom of the demise of globalisation, foreign investment, or international trade, but rather a reflection of how national security threats need to be mitigated in contemporary international business. Buy- and sell-side corporates and investors considering transactions need to factor governments’ foreign investment screening regulations into their deal strategies and execution plans. This is partly a tactical and procedural process of understanding who you need to notify of what and when. However, it is also a strategic and political process. You need to understand the risk profile of all parties to a transaction, and then evaluate how these parties are perceived by different governments given their perceptions of their own national security and important milestones in their political calendars.
Finally, the global footprint and value chain of a target company poses more questions than ever before. Dealmakers are accustomed to bribery, corruption and sanctions focused diligence in their investment processes, though this focus needs to broaden. The same environmental and sustainability pressures that are driving changes in regulations that could affect the valuation of a target company are also generating diligence and reporting expectations about the target company’s suppliers and clients. The same national security concerns that are driving the development of foreign investment screening regulations that could block or impose conditionality on the purchase of a target company are also generating export controls and sanctions that limit the range of suppliers and clients that this target company can engage. The push for second, third and fourth order diligence of suppliers and clients is not solely regulatory. Investors and consumers are also expecting this scrutiny and oversight. Dealmakers will need to scrutinise geographies, product lines, supply chain inputs, suppliers and clients more closely than ever before. Risk assessments are needed to arrive at a breadth and depth of diligence that they and their investors are comfortable with. Dealmakers will also need to be willing and able to exclude parts of a business from a transaction and to include remedial steps around third party risk management into their post-completion plans. Like many trends as we move into 2021, this impetus predates the pandemic. What is new, is the speed at which governments, consumers and investors are moving towards it.