In the wake of coronavirus-induced economic uncertainty, metals companies are evaluating strategic alternatives, with many looking externally to bolster growth, according to the Metals Insider, an industry report released by Brown Gibbons Lang & Company (BGL).
Economic forecasts are in flux in today’s rapidly-changing environment, but many reflect outlooks of a ‘U’-shaped or ‘V’-shaped recovery within the next six to 12 months. M&A will remain integral for competitive positioning heading into an economic recovery.
The U.S. manufacturing sector contracted in March with a PMI reading of 49.1 percent, down from 50.1 percent in February.
“The coronavirus pandemic and shocks in global energy markets have impacted all manufacturing sectors,” commented Timothy Fiore, Chair of the ISM Manufacturing Business Survey Committee.
Corporate and private equity buyers were active across the metals value chain before the market dislocation, illustrated in Q1 2020 transaction activity. Notably, acquisitions by Acerinox, S.A. (VDM Metals), Cleveland-Cliffs (AK Steel), and SFS Group AG (Truelove & Maclean) indicate strong corporate appetite for deal-making. In addition, private equity funds continued to pursue growth platforms and add-on acquisitions, with Palladium Equity Partners (Reading Alloys), The Jordan Company (Arundel Machine Tool), Wynnchurch Capital (Pennsylvania Machine Works), AEA Investors (Texas Metal Printing), and Audax Group (Rockford Fastener) among the deals completed during the quarter.
M&A will continue to be a primary lever to achieve growth targets, with some investors seeing the current environment as a buying opportunity to acquire capabilities and enter new markets. Well-capitalized buyers will continue to be opportunistic at the ‘tuck-in’ level, seeking capabilities that fit into forward strategies.
Also anchoring the M&A market is the significant volume of dry powder on the sidelines that will need to be deployed into growth acquisitions.
- Asset selectivity is higher, but the credit markets are open. Pricing and leverage reflect greater downside protection for lenders to compensate for market risk. However, bank balance sheets are healthy, and private debt funds are plentiful and eager to invest capital.
- Private equity funds are coming off years of record fund raising. Sponsors will be creative in how they deploy capital in the current market, with more seeking minority equity stakes and looking at sharing risk opportunistically.
The sun will come out tomorrow
The economic and societal impacts of the coronavirus pandemic are far-reaching, with ripple effects across industries, geographies, and financial markets. While media reporting of the bad news – economies in recession, equity market volatility, supply chain disruption, curtailed consumer spending – is well-covered, positive headlines are slowly beginning to emerge suggesting that the current market dislocation does have an end in sight.
Consultants predict a post-coronavirus ‘construction tsunami’
Management consulting firm Pioneer IQ forecasts a faster road to recovery in the U.S. economy, with a silver lining of reshoring manufacturing activity, reported Construction Dive. Pioneer IQ predicts at least two more weeks before the crisis peaks in the U.S., and the country begins to see some return to normalcy by mid-May, Keith Prather predicated; explicit in this prediction are his assumptions of unassuming 1) adequate virus containment, 2) development of a successful COVID-19 treatment program, and 3) a reduction in the mortality rate.
According to Construction Dive, Prather highlighted coronavirus-induced supply chain disruptions, particularly involving goods from China, sharing the opinion that “…American businesses will be hesitant to resume orders from this part of the world.” “We believe that going forward there will be a lot of reshoring back in the U.S. where we’ll see an increase in our manufacturing ability here as well as heading into Mexico,” Prather said. Reshoring will spur a ‘surge’ of new manufacturing- and supply chain-related construction projects such as factories and warehouses, he added.
Prather speaks to a ‘construction tsunami’ beginning in the third quarter, driven by pent-up market demand, low interest rates, and a “tremendous amount of liquidity being pumped back into the market.”
EY: Most see third quarter recovery
A majority of corporate executives anticipate a medium-term recovery in the economy, according to findings from Ernst & Young’s (E&Y) Capital Confidence Barometer (CCB) survey released this March. Fifty-four percent expect a U-shaped recovery, or a period of slower economic activity extending into 2021, while a more optimistic 38 percent predict a V-shaped recovery with economic activity returning to normal in the third quarter of 2020. The survey polled more than 2,900 global C-Suite executives in 46 countries and across 14 sectors.
Companies are not delaying external growth plans. Fifty-six percent of survey respondents are actively planning to pursue acquisitions in the next 12 months.
“Lessons have been learned from the 2008–12 M&A downturn which hindsight shows was an opportunity to make acquisitions of high-quality assets that would have fueled faster growth in a recovering market,” commented E&Y Global Vice Chair Steve Krouskos.
Best possible outcome for a quick market recovery
Aggressive central bank stimulus measures and positive economic data from China could support an “always hoped-for V-shaped recovery,” JPMorgan analysts stated. China’s PMI index increased 9.8 points to 50.1 in March, following a 10.8-point decline in February. Business Insider highlighted the Federal Reserve’s purchases of Treasury securities, mortgage-backed securities, and municipal bonds, which reportedly have already helped the asset classes retrace half of their losses. “Such rebounds — which forecast sharp recoveries after short-lived lows — have been the most common trend in economic growth and corporate earnings over the past 50 years,” wrote JPMorgan strategist John Normand in a note to clients. “While the US and global economic output may exhibit a slower, U-shaped recovery as activity takes several quarters to normalize, gross-domestic-product growth and profits could surge to previous highs much faster.”
Takeaways learned based on conversations with clients, private equity sponsors, and lenders
Readying for a rebound. Metals M&A activity was continuing at a brisk pace before the market disruption, with corporate and private equity buyers active across the metals value chain.
Acquisitions still remain a primary lever to achieve growth targets, with some investors seeing the current environment as a buying opportunity to acquire capabilities and enter new markets. Well-capitalized buyers will continue to be opportunistic at the ‘tuck-in’ level, seeking capabilities that fit into forward strategies. Findings from E&Y’s CCB revealed bolt-on acquisitions will dominate planned M&A activity (42 percent of responses), in addition to acquisition of transitional capabilities (31 percent).
Bank balance sheets are healthy. Private debt funds are plentiful and eager to invest capital.
Private equity funds are coming off years of record fund raising. Significant dry powder will need to be deployed in growth acquisitions. Private equity will be creative in how they deploy capital in today’s market, with more seeking minority equity stakes and looking at sharing risk opportunistically.
The credit markets are open… selectively. The cost of debt is going up. Lenders are seeking downside protection in higher spreads and Libor floors. Anecdotally, pricing spreads have increased by an additional 100-200 basis points over Libor, and lenders are reportedly instituting Libor floors of 1 to 2 percent to compensate for increased market risk.
Leverage multiples are more conservative. Equity contribution has increased from 40 percent, on average, to 50 or 60 percent. While company- and deal-specific, we generally expect to see only a modest valuation impact as metals companies already demanded lower leverage.
Balance sheet preservation is top of mind. Some companies are drawing down on their revolvers and credit lines as liquidity protection.
Activity has slowed but not grinded to a halt. Pockets of continued demand are out there.