M&A Outlook: A Financial Perspective
Jeff Schmidt, Executive Managing Director and CEO of CDI Global, sat down virtually with Richard Christopher Whalen to discuss current economy and future M&A outlook. Christopher is an investment banker and author in NYC, chairman of Whalen Global Advisors LLC focusing on banking, mortgage finance and fintech sectors. He is a contributing editor at National Mortgage News and a member of FINRA and Senior Advisor at J.V.B. Financial Group in New York.
Jeff: CDI Global focuses on cross border and global middle market transactions, with the majority falling under $300 million in valuation. Our clients are interested in acquiring companies or seeking buyers for companies that are outside of their home country, often in a completely different part of the world. When COVID started to take hold in Q1 of 2020, many deals came to screeching halt. Now, several months later, around 50% of deal flow has been recovered but some industries are still off by 60-70%.
Q: What is the time frame you see the market recovering?
Christopher: The financial markets have already largely recovered as far as fixed income credit and things such as mortgage bonds in the government and agency world. The disruption was felt more strongly in other industry sectors such as falling energy prices affecting global commodities. But that downward volume trend in corporate debt had actually started before COVID hit, as far back as September. There are a lot of companies having to fold due to debt load or what’s happened to their business model during the pandemic. For example, sectors related to aviation and cruise lines will have to be restructured. Figuring out a new use case model for these assets is a challenge, but also a great opportunity. Retail and office properties are other examples of promising areas.
Jeff: Particularly in the middle market, a lot of people are considering selling either because they have non-core assets in their portfolio or because they are smaller entities that have been hit hard economically. However, because of economic pressures from the health crisis, revenues and profits have been affected. Some sellers fear they aren’t going to get an adequate valuation for their businesses and assets. They prefer to hold out instead of considering current market offers.
Q: How does an advisor convince sellers to get back into the market?
Christopher: This varies widely by industry and whether you can legitimately construct a rationale that justifies valuing a business at a run rate from a previous year. If you can demonstrate that the effects on the business are temporary that’s going to help you support a higher valuation. There are also creative approaches to restructuring assets, such as big-box retailers turning spaces into fulfillment centers and warehouses. However, there are companies who if they have the cash to stick it out will just wait until there is less uncertainty, even when the value is there.
Jeff: CDI Global operates in 30 countries around the world. In many countries, it’s currently very difficult to secure bank credit to sustain them through the crisis. So, owners are looking to non-bank lenders in other countries for credit, including the United States.
Q: Do you see lenders in the US, including non-bank lenders, willing to invest in quality companies in markets hit hard by COVID?
Christopher: To a certain extent yes, but with caution and much higher interest rates to make up for the associated risk of both economic and monetary instability. With the US dollar as the global asset, all other currencies can be a liability to US lenders. Ironically, the chronic shortage of assets due to central bank action is going to yield a decline in US bank lending over the next couple of quarters.
Jeff: There has been a lot of talk about the renegotiation of NAFTA terms and the new agreement.
Q: Do you foresee a lot of deal activity between the US and Mexico?
Christopher: There is certainly a lot of direct investment activity in Mexico, particularly if you focus on the automotive, industrial, and semiconductor industry sectors. It’s much cheaper in terms of resources to run that industry in Mexico as compared to California, for example. The growing political animosity between China and the US strengthens investment opportunities in The Americas. I think we will see growth in investments in the more politically and economically stable countries such as Mexico, Costa Rica, Columbia and some in the Caribbean Basin. In the south, the stability of Uruguay is becoming a magnet for people and capital while Argentina implodes under socialist rule and Brazil continues to be uncertain.
Jeff: There are distressed companies with established brands and good assets in Europe. Our advisory services help navigate cross-border transactions for these companies. As you know, buying a foreign entity can be quite complex.
Q: From a banking and credit standpoint, do you see US buyers looking more intently at cross-border opportunities?
Christopher: There is definitely an interest in Europe on the part of American funds. We’ve already seen some activity, with interesting opportunities particularly in Germany, France, the UK, and Poland. There are also countries like Spain and Italy that need a lot of restructuring with smaller banks that need to be recapitalized, so there is great potential there. Because of the stability of Western Europe, we should see some interesting deals within the next year or two – perhaps including banks.
Jeff: We anticipate M&A opportunities in the United States banking community, particularly with consolidation and realignment.
Q: How do you see American financial service consolidations and restructuring unfolding?
Christopher: In the US, it’s the smaller banks and finance companies under $10 billion that are the most interesting, and most of those banks fall under $3 billion. They grow very quickly and are active in the mortgage space. Even with interest rates falling, those are going to be valuable, high-multiple assets. Rocket Mortgage just went out to the public at 14x earnings in early August. The key to buying a bank in the US is to first and foremost have a plan. Show an organized three-year projection, including what business you are going pursue, to show regulators. Or how do you plan on merging with an existing bank? That tends to be best way to do it. There is also always opportunity to get creative within consumer finance, for example in Fintech.
Jeff: The United Kingdom has changed its treatment of capital gains and more changes could happen to raise revenues in the face of increasing government debt. One of the ideas we’ve heard floated is treating capital gains like ordinary income.These changes affect entrepreneurs and other sellers.
Q: If such tax laws are passed by governments in Europe and the US would you advise selling before the laws changed?
Christopher: We’re facing a political inflection point with the upcoming election in the US. Whoever is in the White House will be facing a giant financial burden. So, you can expect to see a tax increase. If you have clients motivated to sell during this tax year, they may be very well served by that strategy.
Jeff: Thanks for sharing your perspectives with CDI Global. We appreciate the expert financial perspective you bring to the unprecedented challenges for M&A in the current environment.
Christopher: Happy to be here, thanks for a great interview.