By Charlie Solnik, Ryan Tenerowicz (California Polytechnic University), and Steven Skomra (Georgetown University)
Report Head: Timur Kurbanov (New York University)
As the COVID-19 pandemic continues into the second quarter of 2020, countries in North and Latin America are taking action to combat the adverse economic effects of the disease. Many people are restricted from travelling in an effort to slow the spread of the disease, which has negatively impacted business’ operations. New fiscal and monetary policies have been enacted in an attempt to counteract the economic decline, but numerous businesses still face bankruptcy regardless. The pandemic has also caused a reduction in M&A activity.
North America has seen a 3% decrease in M&A volume, with total transactions valued at $466 billion in Q2, compared to $452 billion the same time last year. Q2 deal volume for the U.S. saw a small decrease compared to the rest of the world due to several large M&A deals with transaction values over $10 billion. Latin America saw a more severe decrease, with at least a 30% to 40% decrease in M&A volume in Q2 2020, and a 77% decrease in deal value for the first half of 2020 compared to the same time last year. In the first six months, M&A volume in Latin America saw 199 deals with a total transaction Geopolitical & Macroeconomic Outlook Quarter 2 USA Mexico Canada Brazil value of $8.1 billion, this is down from 316 deals with a total transaction value of $35 billion in the same six month period last year.
United States of America
Travel Bans and Shelter-In-Place
The implementation of travel bans, and shelter-in-place orders has had widespread effects on daily operations and has led to numerous practical problems for companies. A myriad of M&A negotiations is slowing down or halting due to decision-makers’ inability to travel and obtain important original documents in a timely manner. This coupled with the shelter-in-place mandates that have forced government officials and civil servants to work remotely, has the potential to slow the regulatory and antitrust review process. As the negotiation process drags on, so do the associated costs, increasing the likelihood of a transaction’s failure. Beyond the effects on active mergers or acquisitions, these orders are also setting the stage for a plethora of mergers and acquisitions in the future. The orders are primarily impacting the business of companies that rely on their in-person consumers for revenue. Numerous retailers are facing issues as they are forced to rely on their online offerings for revenue. These orders may force companies into bankruptcy, paving the way for future acquisitions or mergers.
During the COVID-19 pandemic, bankruptcy filings have significantly increased, averaging 600 Chapter 11 filings in the U.S. per month since January, which is up 31% compared to the average Chapter 11 filings per month in 2019. This can largely be attributed to disrupted supply chains, and a decrease in consumer spending. Several well-known large companies, like Hertz and J Crew, have filed for bankruptcy citing issues with over leveraging and a decrease in incoming cash flow due to the pandemic. These bankruptcies will cause a ripple effect for businesses and creditors. The recent filings will congest bankruptcy courts and since many of these companies have large debt balances, their creditors will have a difficult time recovering their investments or expected payments. On the brighter side, the increase in bankruptcies will open opportunities for companies with larger cash balances to acquire bankrupt firms at a discount. However it should not be expected that this will significantly increase M&A activity, as it is unlikely that large companies will look to acquire over-leveraged businesses and agree to take on a large increase in debt considering many firms are in survival mode due to the COVID-19 pandemic.
US Fiscal & Monetary Policy
Following the outbreak of the COVID-19 pandemic, the Federal Reserve and U.S. government have been forced to take unprecedented actions in order to stabilize market turmoil and support short term economic activity. The first move made by the FOMC came back in March when the federal funds rate was cut from a range of 1.50% to 1.75% percent to a range of 0% to 0.25%. Chairman Jerome Powell has stated that rates will remain at this target range until the economy is on track to achieve its maximumemployment and price-stability goals despite President Trump calling for a move to negative interest rates. In theory, the move to 0 or lower interest rates could encourage more M&A activity postCOVID as companies look to spend their larger cash balances, however this increase likely wouldn’t be seen until economic conditions begin to increase, meaning it will have little effect on M&A transactions in the next one or two quarters. However, in practice, a move to negative interest rates, while unlikely, could signal low economic growth and future uncertainty causing companies to choose either to hold on to their cash or spend it on foreign deal activity. In 2015 when Japan moved to negative rates, Japanese companies were involved in $90.1 billion worth of cross-border mergers and acquisitions, more than doubling the value from the year prior. Additionally, the FOMC has undertaken asset purchases in the form of quantitative easing and credit extensions to various economic sectors to support businesses. In June, the FOMC committed to purchasing $80 billion per month in Treasuries and $40 billion in mortgage-backed securities until further notice. These programs from the Fed, as well as over $3 trillion in Congressionally authorized coronavirus relief, have created speculation regarding a shift from a deflationary environment to one of long-term inflation. This could significantly reduce future M&A transaction volumes; such was the case throughout the 1970’s when annual M&A volumes in the U.S. dropped from 5,152 transactions in 1970 to only 2,128 annual deals in 1979. However, such effects likely would not be seen for some time.
Canada & Mexico
Replacement of NAFTA
A modernized proposal for the North American Free Trade Agreement (NAFTA) entitled the United StatesMexico-Canada Agreement (USMCA) was recently ratified in March and was placed into effect as of June 1st. Specifically targeting the auto industry, the USMCA includes several new provisions targeted towards reducing the outsourcing of manufacturing jobs from the US. This coupled with the strengthening of labor laws incentivizes a return to US manufacturing. The agreement’s manufacturing provisions coupled with rising tariffs on goods and materials from China could potentially lead companies to reorganize their supply chain with a focus on proximity. This presents an opportunity for vertical GLOBAL M&A OUTLOOK REPORT – Q2 2020 11 mergers as companies seek to lower their manufacturing costs. Additionally, a provision was removed from the trade deal that would have required all three countries to provide at least 10 years of exclusivity for biologics. As of this report, there are no exclusivity requirements in place in Mexico outside of the current exclusivity period enforced by NAFTA. Thus, the replacement of NAFTA could potentially lead to a dissolution of Mexico’s exclusivity period. Companies typically rely on their products’ market exclusivity period to cover their R&D costs, and an absence of this period would create liquidity issues for many companies. These failing companies may subsequently be bought by competitors at a bargain.
Similarly, to North America, M&A activity throughout Latin American countries has reduced dramatically because of the coronavirus pandemic. With the number of deals and total transaction values falling to record lows, the situation in Latin America may be even more bleak than that of North America. Latin America was one of the last global regions to be struck by COVID-19 with the first recorded case not coming until February in Brazil. As a result of the late arrival as well as a failure of countries within the region to properly enforce lockdowns and other safety protocols early on, the region continues to experience rising case numbers. Brazil has been hit especially hard as it is now the world's second most infected country after the U.S. with 800,000 cases and 40,000 deaths. The result has been destroyed economic activity throughout the region and record low deal volumes, which will likely take longer to recover from than other more developed regions.
Given the current economic environment throughout North and Latin America, it is unlikely that M&A activity will return to pre-COVID levels in the near future. Instead, most companies will look to utilize their built-up cash reserves, and possibly take on more leveraged positions, to preserve financial stability. However, given the increase in recent bankruptcy filings, certain companies with large cash balances may look to take advantage of the situation by acquiring newly bankrupt companies for discounted prices. Deal volumes over the next 2 to 3 quarters will depend on how quickly countries are capable of reopening certain industries whereas current geopolitical agreements and fiscal policies may have long-term repercussions.