Little to Buy and Even Less to Spend: M&A During Q1's Coronavirus Pandemic

As the coronavirus pandemic ripped around the globe, the modern workaday world went into lockdown. Businesses shuttered, restaurants emptied and travel ceased. The COVID-19 crisis broadened and deepened as the opening months of the new decade went along, infecting hundreds of thousands of people and stifling trillions of dollars of economic activity around the globe.

Coronavirus, which first emerged in China in late December but only really got recognized in the West in February, started as an alarming public health concern and has subsequently metastasized into a dire threat to economic health. The worst viral outbreak in more than a generation – along with the subsequent measures to halt the spread of the deadly virus – ended Wall Street's longest-running bull market, plunged the credit market into a quarantine of its own, and wiped out millions of jobs.

No market remained uninfected by coronavirus, and certainly not one as speculative as tech M&A. Spending on tech deals announced in Q1 dropped nearly one-third below the average over the past half-decade, slumping to the lowest quarterly level in two years, according to 451 Research's M&A KnowledgeBase. Our data shows acquirers announced some 878 tech transactions worth a collective $84bn from the start of January through the end of March. And yet, given the mechanics of the M&A market, Q2 is all but certain to drop from Q1.

The ominous end to Q1 notwithstanding, it's pretty clear that the full impact of the pandemic has only started to show up in acquisition activity. As one indication of the sudden and stark deterioration of business, consider the flow of monthly spending in Q1. In both the two opening months of 2020, when concerns about the virus weren't anywhere as acute as they were in March, tech acquirers doled out dollars pretty much at the same pace as they had in 2019.

That ended abruptly as the pandemic panic took hold. The M&A KnowledgeBase shows spending on tech transactions in Q1's final month plummeted two-thirds compared with the first two months, declining to the lowest monthly total since 2013.

By virtually every measure, the picture got bleaker as the quarter went along – more infections and more deaths from the virus, along with more restrictions and more disruptions from the efforts to combat the pandemic. Hope dwindled rapidly as the plague spread rampantly. To underscore the unprecedented deterioration of business in Q1, consider the findings from a special survey of more than 800 IT buyers and users done by 451 Research's Voice of the Enterprise (VotE) last month.

At the start of the VotE survey period (March 10-11), roughly four of 10 respondents thought their businesses could run 'indefinitely' without experiencing a major disruption, such as not being able to pay bills or deliver services. A week later, just half the number (21%) thought their businesses would get through the coronavirus pandemic unscathed. (For context, the number of confirmed COVID-19 cases worldwide tracked by Johns Hopkins University doubled during that mid-March survey period. Ominously, the number of cases more than tripled in the final half of the month.)

When businesses are worried about surviving, they aren't going to be acquiring. In order to transact, buyers need two things: confidence and cash. (Or, more colloquially, they need the will and the means to do a deal.) Both of those indispensable commodities, much like toilet paper and bleach, were pretty hard to find in March.

Liquidity dried up as business ground to a halt. That forced the Federal Reserve as well as US lawmakers to take steps that far exceeded anything they did to blunt the impact of the Credit Crisis a decade ago. For instance, the Fed has cut interest rates back to basically zero and used its massive balance sheet to purchase government debt in recent weeks, just as it did in 2008-09. However, unlike during the previous recession, the Fed now also plans to lend directly to US businesses besides banks – something it has never done before.

Similarly unprecedented is the $2 trillion 'stimulus package' that Congress and President Trump rushed to pass at the end of March. The package, which is about twice the amount that Washington doled out in support of the US economy during the Credit Crisis, brings a mix of direct cash payments, newly available loans and other fiscal measures designed to keep businesses and households afloat until the US economy can emerge from its medically induced coma. Yet even this historic amount of aid may not be enough. Many economists and legislators are already roughing out plans for a follow-up package that could also be measured in the trillions of dollars.

All of the uncertainty around the coronavirus pandemic and its broader economic impact is further complicating already complicated M&A negotiations. To properly value any asset, buyers and sellers need stability. Accurate pricing requires some kind of foundational certainty on which to base assumptions or build best-guess models. Until now, both the bid and the ask have generally reflected an 'up and to the right' trajectory for business.

By our calculations, the average tech deal in 2019 went off at a record 2.7 times trailing sales, a full turn higher than the start of the decade. M&A multiples across all of tech have ticked higher for each of the previous three years, according to the M&A KnowledgeBase.

Why the increase? Broadly speaking, those rich valuations have been supported by underlying growth of IT spending, which has outpaced virtually all other markets. However, pinched by the coronavirus outbreak and accompanying recession, budget dollars are no longer flowing like they had been. To illustrate, consider that in its forecast last November, S&P Global Ratings was projecting about 3% growth in IT spending in 2020. By March, it had revised its forecast to a decline of 3% for the year.

As dealmakers are discovering right now, it's extremely difficult to price in a pandemic. What happens to those escalating valuations when they run into the more-powerful forces to 'flatten the curve?' How do you adjust for an anomalous event like a pandemic? Is it even possible to separate the epidemiological from the economic?

These are questions that will take months or even much longer to answer fully. But the early indications are unambiguous: Tech M&A prices are coming down. At just 2x sales, the average multiple in Q1 basically matches the level that shell-shocked buyers were paying when they emerged from the Credit Crisis.

Just as valuations are headed lower, overall tech M&A activity levels are likely to tick down as well in the coming months and quarters. That decline hasn't really shown up yet because the transactions we are recording right now in the M&A KnowledgeBase were pretty much all either already done or in the end stage when the coronavirus outbreak upended business and suddenly introduced far more risk and unknowns into the acquisition process.

From the broader M&A market perspective, hunkered-down dealmakers are currently spending down the pipeline. And because of the uncertainty swirling around the globe, the pipeline isn't getting replenished. There are prints now, but not much coming behind them. Certainly not any deals of size, whether large-scale transformative transactions or stratospherically priced bets on unproven unicorns.

As to how long we'll be doing deals in 'crisis mode,' a look back at last decade's financial pandemic, the Great Recession, provides at least a rough timeline for the lag between economic/financial calamities and when they show up in tech M&A activity. Most of the confidence-shattering events of the Credit Crisis – such as the bankruptcy of Lehman Brothers and the collapse of AIG – took place in 2008. The S&P 500 Index plummeted nearly 40% that year, erasing trillions of dollars of value from stocks around the globe.

Yet for most investors and businesses, the worst economic downturn since the Great Depression turned upward in relatively short order. The recession officially ended in 2009, and Wall Street's bull market began its historic gallop. The S&P 500 returned about 25% in 2009, kicking off a nearly uninterrupted rise that saw the index almost quadruple over the next decade.

Unlike those markets, tech M&A took much longer to recover. After bottoming out in 2009, tech acquisition spending remained exceptionally weak for three additional years. (From 2010-12, tech buyers averaged just half the annual spending they had in the three years immediately leading up to the recession, according to the M&A KnowledgeBase.) Our data shows it was only in 2013 that the value of global tech deals regained 2008's level. In other words, a two-year economic recession caused an M&A slump that lingered painfully for a half-decade.