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Beyond COVID-19 PE Playbook

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Beyond COVID-19 PE Playbook Beyond COVID-19 PE Playbook TRANSACTIONAL POWERHOUSE 2 Beyond COVID-19 PE Playbook Contents Distressed M&A 03 PIPEs / Minority investments 07 Public-to-Privates (P2Ps) 12 Valuation bridge tools 15 M&A: The new normal 21 Debt buybacks 24 3 Beyond COVID-19 PE Playbook 1 Distressed M&A 4 Beyond COVID-19 PE Playbook Distressed M&A Any downturn tends to produce a surge of distressed M&A opportunities, and the current crisis will be no different. Investments in distressed companies follow a different set of rules to “normal” M&A transactions, bringing additional complexity in terms of the stakeholders involved and deal structuring, as well as a particular set of challenges for due diligence and buyer protections. Structuring considerations • Loan-to-own strategies: Credit funds are well-versed with taking positions in capital • A complex cast: Restructurings often entail structures as part of a loan-to-own strategy a broad range of protagonists - the equity, or otherwise. Even where their fund terms senior debt, junior debt, bilateral country debt permit investment into debt or mezzanine providers, trade creditors, unions, government(s) securities, many buyout funds have stayed clear and management. Understanding early on of such structuring. As we enter a period of where the value breaks, who is driving the deal, greater financial strain on business, PE should conflicts of interest, and who can spoil a deal, remain open-minded and creative about more are critical. Where distressed funds are involved, structured deals to achieve control, e.g. around be aware that their tactics and strategies can distressed add-on targets. Having a clear differ significantly from those of traditional view on the capital structure sensitivities and buyout houses. endgame is critical. • Cram-down/process: Cramming down out- of-the-money creditors and/or equity will be the critical catalyst as to how a restructuring is framed. Techniques vary from country to country, and there may be scope to avail of more debtor-friendly legal systems. Due process is not just a sell-side issue. Buyers need to ensure the restructuring is immaculate to avoid claims and/or the deal being unwound. Court sanctioned restructurings may provide legal comfort. It would be rare for the “sell-side” to provide any meaningful indemnification from claims from crammed-down creditors, so being into the detail of the restructuring plan and its efficacy will be critical. 5 Beyond COVID-19 PE Playbook • Contractual protections: Sellers are more Facilitating a distressed deal likely to offer limited (or no) warranties or other • Time pressure: Sale processes are nearly contractual protections on the basis that there always on an accelerated basis as insolvency are known issues and the business is therefore looms. There is often insufficient time for a sold ‘as is’, and/or because the seller itself is normal, full due diligence process. facing liquidity and/or solvency issues. • Access to information: One of the biggest • W&I: Warranty and indemnity insurance is challenges for distressed M&A is access to often still available in a distressed situation, quality information. Promoters of the although a new set of considerations will apply: distressed company have either already been • insurers will want to understand the factors removed or have limited financial upside. which led to the target being distressed, In such circumstances, they may not be and the quality of due diligence will be particularly cooperative and, in the case of closely scrutinised (in particular, “internal” historic mismanagement, the information due diligence may be problematic, or at they leave behind may be incomplete and/or least lead to exclusions); poorly organised. • the definition of “loss” will need to be • Conversion risk: Buyers potentially need to carefully considered and agreed up front; commit material resources early in the process in order to address challenging due diligence • an indemnity basis may be more needs; but because of the more structured appropriate than the more usual damages nature of a distressed M&A deal and the basis; and multiple protagonists, the conversion prospects may be less clear early on. • synthetic policies are gaining traction in the context where sellers can’t or won’t • Costs: In the distressed M&A arena, it is less give warranties, especially for businesses likely that a seller can absorb or mitigate in certain jurisdictions and sectors (e.g. those costs through break fee agreements or Northern Europe and asset heavy sectors). similar. Additionally, obtaining exclusivity (often They can be available even where there is a prerequisite for a buyer to incur material low seller/management engagement (i.e costs) may be difficult in a fluid distressed the lack of a disclosure letter is not fatal) sale scenario where seller stakeholders must and although pricing tends to be higher transact quickly and are seeking to keep all than for a “normal” W&I policy, it is on options open. a downward trend, with premiums now typically between 1-2% of the amount of • Timeline and certainty: Sellers/stakeholders cover in the UK. likely require a quick sale and may place increased weight on a buyer’s antitrust position. • Management incentivisation: Finally, as Similarly, if the nature of the asset or the identity with any buyout, the MIP discussion may of the buyer makes government intervention create alignment between a PE house and possible, buyers should be prepared to enter into management, which could help facilitate negotiations with government authorities in an the deal. Be cognisant of the impact of effort to reduce conditionality and keep to a the restructuring on management. Have compressed timetable. management lost their investment in the old deal? Can you be creative and replicate that • Asset deals: Buyers often prefer an asset in the new deal (i.e. by providing a company purchase transaction in order to limit loan to assist management in funding their assumed liabilities, but these are generally new equity participation on a non-recourse more complicated and slower to execute. basis)? This will raise complex tax issues but Asset transactions typically require extensive if done correctly can be an important enabler diligence around transferability of assets, and for the deal. there is often also a potential requirement for third party consents. 6 Beyond COVID-19 PE Playbook The “failing firm” In the UK, the relevant framework for the CMA to assess a failing firm scenario defence: an opportunity (as most recently considered in the for PE? Amazon/Deliveroo transaction) is: PE bidders should also be aware of (i) would the target business exit the market absent the the opportunity that the downturn may transaction? bring for add-on deals of distressed businesses, which were previously (ii) would there have been an considered too hard due to anti- alternative buyer for the trust reasons. A number of anti-trust business/its assets? and regimes have a ‘failing firm’ concept, whereby in certain circumstances an (iii) what impact would the alternative framework will apply for exit have, compared to the assessing the merger. These deals are competitive outcome of rare and highly fact-specific but may the transaction? offer opportunities, both for add-on creativity and PE intervention where such deals are proposed by others and PE can show itself as an “alternative purchaser”. 7 Beyond COVID-19 PE Playbook 2 PIPEs / Minority investments 8 Beyond COVID-19 PE Playbook PIPEs COVID-19 has forced everyone to talk about liquidity relentlessly. Many listed companies may have fixed their immediate liquidity needs but will need more funding going forward. This likely means that, alongside the usual secondary capital raising structures, we will start to see more PIPEs (private investments in public equity), which should give rise to opportunities for PE funds. The US has seen a significant number in the year to date - over 600 PIPEs raising over $40 billion. Why now? • They are also relatively common in some European countries, with the notable exception • Many companies have reacted quickly and of the UK. However, there are some signs in taken steps to reduce overheads and to the UK that the tough stance institutional preserve or create liquidity, drawing down investors have taken on pre-emption rights on revolving credit facilities or putting in place (and the vocalised desire for issuers to new working capital facilities. Others have respect these) may now soften, given the tapped the equity markets. However, early unprecedented demand for liquidity expected movers may have had an advantage while in certain sectors. the window was open; the “equity story” of second movers may face greater scrutiny • Creative investors will look at legal and and shareholders may be less willing to fund regulatory parameters and look to structure traditional secondaries in the future. around them, (e.g. combination of equity and (convertible) debt, or quasi-debt) and • Dry powder is at record levels and valuations of investors may start to participate alongside listed companies are currently at a historic low traditional institutional shareholders in further point in many sectors. equity issuances. • PIPEs can be put in place quickly - they • A PIPE may be combined with an M&A deal - frequently have short timetables and are often as part of an acquisition of assets from a listed structured in a way that avoids the need for company, a PE buyer could agree to make a shareholder approval or a prospectus. separate PIPE into the seller. • PIPEs have for many years been a common feature of the US market, where pre-emption rights are not a default feature of corporate laws on new share issues. 9 Beyond COVID-19 PE Playbook Key issues • Information sharing: While an issuer might share some limited due diligence materials with • Market resistence: Although PIPEs have been a prospective investor, as a general rule, the prominent in the US and in some European issuer must not share “inside information” (in countries (especially in the healthcare and Europe) or “material non-public information” (in technology sectors) they have not traditionally the US) with a potential PIPE investor.
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