International law firm Herbert Smith Freehills (HSF) says levels of merger and acquisition (M&A) activity are increasing around the world, having dropped off significantly when the Covid-19 pandemic first hit.

“While we are seeing some distressed M&A as activity picks up, government support packages, such as furlough schemes and moratoria on creditor proceedings, mean that we have not yet seen the levels we might otherwise have anticipated,” the firm states.

HSF adds that it is, however, seeing many “quasi-distressed” deals, where companies need to dispose of assets to support their core business but are not on the verge of insolvency.

The firm also continues to see “business as usual” M&A activity, as well as deals that were paused as the pandemic took hold but are now proceeding.

Governments are also participating in M&A, with the aim of boosting their economies or protecting skills and jobs.

HSF notes that it is witnessing some transformational deals, as well as increased activity by private equity and other financial buyers. Many of these transactions are early stage so may not ultimately come to anything, but it is indicative of an increased willingness to engage in M&A.

“As stability returns to the markets, we are also seeing companies being more confident in rejecting what they perceive to be low-ball offers.

“Another trend is the increase in the number of special purpose acquisition vehicles being listed – these are shell vehicles which are listed as part of an initial public offering (IPO) and the proceeds from the IPO are then used to acquire one or more companies in a particular sector or which meet some other specified criteria,” HSF explains, adding that this is mainly confined to the US at the moment but the firm expects to see increasing numbers in Europe too.

In terms of sectors, unsurprisingly, the healthcare sector has seen a lot of activity. Technology companies too have engaged in significant M&A activity in recent months.

The energy and infrastructure sectors also remain active, especially in renewables and digital infrastructure.

Whether a transaction is stressed, distressed or “business as usual”, the pandemic cannot be ignored or overlooked, says HSF.

CHANGING DUE DILIGENCE

HSF states that the pandemic has likely caused a shift in focus in some aspects of the due diligence exercise. 

The due diligence exercise will have to have an increased focus on certain key areas such as supply chain risk, including force majeure and the possibility of further waves of the pandemic.

It will also be important to understand what steps the target business has taken in response to the pandemic, for example, as regards payment of rent, and what activities the target may have undertaken – or carried out differently – during Covid-19 which could give rise to liability.

Moreover, HSF believes that a particular area of focus is likely to be environmental, social and governance (ESG) issues, but scrutiny over these issues was increasingly prevalent even before the pandemic. 

In particular, a buyer will likely be interested in employee issues, specifically health and safety and compliance with employment law.

Buyers should ensure that ESG issues are explored in detail, both in the context of the law as it currently stands but also in light of how law, regulation and expectations will likely evolve, at least over the short to medium term, and any potential reputational risks.

In terms of cybersecurity, the law firm says the pandemic has caused a rise in the need for cybersecurity and a need to address data privacy issues, which could lead to regulatory sanctions and reputational issues in the future.

This should be a particular area of focus for buyers, it advises.

Further, companies that have taken advantage of government support may be subject to restrictions on future transactions, such as paying dividends. Drawing on government support packages may also impact a business’s future profitability – for example, if it has deferred payment of tax which will become due in the coming months.

“It will be important to understand what support has been drawn on and any consequences for the business or investment model. Reputational considerations will also be important – we have seen some companies electing not to draw on or repaying government support packages, while other companies have come under close scrutiny where they have drawn on support and continued to pay dividends or large bonuses,” says HSF.

The law firm expects to see distressed transactions driven by companies needing cash or financial creditors forcing disposals. A distressed M&A transaction has a number of features that are not seen on other M&A transactions and which participants should be aware of.

The firm explains that a distressed M&A transaction may involve the buyer transacting directly with the seller, either as the seller tries to avoid insolvency or as it goes into an insolvency process, or dealing with an insolvency practitioner.

Where a company is facing insolvency, any M&A process will have to be executed as quickly as possible, sometimes over the course of a matter of days rather than the weeks or months normally spent on a transaction.

As a result, it is unlikely that a buyer will be granted an exclusivity period and any due diligence exercise is likely to be far more limited than usual.

An insolvency practitioner is also unlikely to give any warranties or indemnities. Even if contracting with the corporate itself, rather than an insolvency practitioner, a buyer should not assume it will have recourse against the seller as it may be insolvent by the time a claim is made.

“Rarely have events accelerated so rapidly or so radically as they have in the course of the Covid-19 pandemic. We expect the crisis to operate as a catalyst for change and, as a result, there will be opportunities for those with capital to invest or a desire to expand,” concludes HSF.