M&A in the Age of COVID-19

As a middle market investment bank focused on the business & information services, education, healthcare services and consumer growth industries, we thought it might be helpful to provide some perspective on what we are seeing regarding the M&A environment during the global pandemic.

Markets dislike uncertainty and uncertainty certainly abounds today. That said, with each passing day, it does appear that some of the “fog” is lifting, perhaps imperceptibly at first, and that a clearer picture emerges of what we are dealing with in regards to COVID-19 with respect to health, economic implications, and government interventions. M&A has absolutely and dramatically been impacted, though the landscape is best viewed by the sector and specific stage a deal exists.

For deals presently under LOI that are approaching closing, deals are still getting done, though typically not without some significant reworking of previously agreed-upon terms as buyers react to a fluid landscape as relates to credit markets, seller performance (present and projected) as well as buyer performance (in the case of strategic buyers).  Given the significantly riskier environment, we are seeing increased reliance on rolled equity, earnouts, seller paper (oftentimes with a low interest rate) and other structural mechanisms that permit appropriate sharing of risk.  In the coming months, we also expect to see more minority deals that perhaps serve as “plan B” for control deals encountering issues.  Deals in the healthcare space (and those viewed as “essential”) and to a lesser degree, the technology space (and recognizing there’s crossover between the two) are, for the most part, continuing to forge ahead.  From our perspective, strategic buyers (including those owned by PE) are really the only active acquirors at this moment, as PE firms looking at new platform investments have largely temporarily stepped aside given their focus on portfolio companies.  Notwithstanding the aforementioned, we do expect to see PE resume activity fairly quickly, given, in particular, more than a trillion dollars in investable “dry powder” awaiting deployment.  On the financing front, while credit markets have tightened a bit, leverage levels have decreased and downside scenario thresholds have increased.  Leverage is still available, albeit on a more selective basis.  Strategic buyers expanding an existing facility are certainly better positioned than buyers relying on a new lending relationship.

From a legal or contractual perspective, material adverse effect (“MAE”) clauses and the inclusion or exclusion of COVID-19-related language, covenants that provide flexibility for rapid changes in business practice due to COVID-19, and language speaking to automatic date extensions  (perhaps due to regulatory authorities being backed up, understaffed and/or simply not physically open for business) are becoming integral.

Deals in other spaces (non-healthcare or non-tech), for the most part, are hitting the pause button and/or “slow rolling” ahead, with recognition from all parties involved that deal-term modifications may well be required in the future to adjust appropriately to changing situations.

For deals that are in the market and past management presentations, the story is much the same -continue to move forward but at a much more measured pace,  recognizing that crucial due diligence is more difficult to achieve, if not impossible, given shelter in place, work from home and lack of travel throughout the economy.

For deals that are not yet in the market, work on the preparation front (e.g., drafting of marketing materials, assembly of data room) continues with the recognition that things need to settle down before a new deal is brought to market.

M&A activity will undoubtedly decline in the coming months, but we expect a resumption of activity, likely at lower volumes and valuations (though this will be sector dependent) to resume in the second half of the year, presuming COVID-19 is addressed from a medical perspective, and a normal (relative term) business environment returns.  We expect to see companies that performed well through these uncertain times be the first back to market, and to be rewarded with premium valuations. Across our industry verticals and client base we are seeing strong performance thus far in direct to consumer (“DTC”) models broadly speaking, food & beverage, pets, online education, essential healthcare (particularly telemedicine) and certain technology plays (particularly those that focus on or support the aforementioned industries).

As a firm with a significant buyside practice, we would also expect to see a resumption of strong buyside-driven M&A, particularly by larger, well-capitalized firms.

During these uncertain times, MHT is committed to providing helpful information and strategic counsel to individuals and firms in need.  We welcome further discussion:

Business & Information Services:  Mike McGill (mmcgill@mhtpartners.com) or Kevin Jolley (kjolley@mhtpartners.com)
Education:  Shawn Terry (sterry@mhtpartners.com) or Alex Hicks (ahicks@mhtpartners.com)
Healthcare Services:  Taylor Curtis (tcurtis@mhtpartners.com) or Alex Sauter (asauter@mhtpartners.com)
Consumer Growth:  Craig Lawson (clawson@mhtpartners.com) or Patrick Crocker (pcrocker@mhtpartners.com).

K-12 Education Technology in the Midst of COVID-19

In this time of economic turmoil triggered by COVID-19, the demand for education technology (“edtech”) solutions is at its peak. With more than 30 million K-12 students ordered to stay home, online learning has become the new normal. In the past, online learning was a luxury but now plays an essential role in enabling educators to teach, allowing students to continue to learn and grow during this unprecedented crisis.

Prior to COVID-19, many K-12 schools and districts made great strides in working to blend edtech solutions into regular classrooms. However, these incremental efforts have proved to have limited impact in light of the sudden disruption. Educators and school districts are in a panic as they scramble to digitalize nearly a full semester of content for students in every grade. What they foresaw education becoming over the course of time has become the required solution now. Luckily, the demand for these technologies is fully supported by progressive minded-educators, the government and the rich ecosystem of e-learning providers.

U.S. Congress is implementing various emergency COVID-19 stimulus packages including a $3 billion emergency aid package to support the learning needs for early childhood education and K-12 schools.[1] Realizing that online learning is the new standard, the government has acted accordingly for the sake of all students. One problem that they’ve realized while implementing such aid is that a large percentage of students don’t have a reliable way to get online. Specifically, 14 percent of households with school-aged children do not have internet access, most of which are households with an aggregate income of less than $50,000 a year.[2] As if completely transitioning learning online wasn’t a heavy lift in itself, closing the internet access gap is an added intricacy that that government, educators and providers have tackled head-on. In the past weeks, the Federal Communications Commission has worked to waive late fees for existing internet subscribers and increase data caps for mobile hotspots so that students can have the internet access they need to learn. In addition, internet providers such as Spectrum and Comcast are offering free service for 60 days to new customers with K-12 or college students at home.

Educators and school districts, too, are taking creative measures to smoothly transition learning online and bridge the internet access gap. While some school districts and educators have no concerns surrounding students’ access to online lectures and assignments, others do. Teachers in these types of districts are working persistently to find ways to connect their students to learning content. Solutions like partnering with local TV programs to deliver content, teaching via phone calls and the creation of take-home learning boxes are being implemented. In Los Angeles, districts are partnering with local PBS stations and the city’s district to generate remote-learning initiatives tied to TV programs instead of internet.[2] These collective efforts to close the internet access gap is both bridging the potential longstanding chasm that the COVID-19 epidemic could leave in student’s development and helping cope with the new reality of online learning.

Most importantly, K-12 edtech companies like McGraw-Hill, Cengage, Chegg, Coursera, Instructure and Wiley now play an essential role in educating our country’s students, and they are rising to the occasion. Both Cengage and Wiley have made their digital content free for the remainder of the current school term. In addition, companies like Zoom have lifted the 40-minute meeting limit on their free basic accounts for K-12 districts.[3] At the forefront of the new normal, edtech companies are finding affordable ways to implement themselves into every school district and increase their prevalence as a new backbone to the current education structure and economy, in general.

The implications for edtech in this unprecedented time have shifted drastically.  As online learning has quickly become the new normal for all students, edtech has become a necessity rather than a luxury . . . an essential rather than a bonus  . . . a mainstream commodity rather than a niche amenity.  This will be the way it is for as long as the need for education sticks around, which is forever.

[1] http://blogs.edweek.org/edweek/campaign-k-12/2020/03/coronavirus-aid-package-education-democrats-3-billion.html
[2] https://www.edsurge.com/news/2020-03-20-here-s-what-schools-can-do-for-the-millions-of-students-without-internet-access
[3] https://campustechnology.com/Articles/2020/03/16/Free-and-Discounted-Ed-Tech-Tools-for-Online-Learning-During-the-Coronavirus-Pandemic.aspx?Page=1

Perspectives from a Consumer Lens – Rays of Light Amongst the Storm Clouds

First and foremost, we hope everyone is safe and healthy. Given the abundance of uncertainty and ambiguity in today’s world, we thought it might be helpful to provide some perspective on sectors of the consumer economy that are doing well, relatively speaking.

Clearly there are sectors suffering mightily right now and net net, there will be winners and losers from a structural perspective once the pandemic settles down and “normalcy” (a relative term) returns.

Focusing exclusively on the good (in part because the bad is widely publicized), we want to share conversations and anecdotal perspectives we are hearing from our clients and prospects:

1.Direct-to-consumer (“DTC”) models, in general, are holding on well. Of course, it depends on exactly what products are being sold and at what price point, but relative to traditional brick-and-mortar, distribution-dependent vendors, DTC-focused models are outperforming. A recent conversation with an “on trend,” plant-based food producer with a sizable presence in traditional grocery, food distribution and DTC reported that food distribution is obviously suffering, grocery is performing well, and DTC is “shooting the lights out.”

More industry-specific (vs. business-model specific) correspondence provides the following anecdotal (and admittedly limited) evidence:

2. Outdoor products manufacturer (100% DTC) – business has been strong as this producer’s older, healthier and active customer base finds themselves with extra time on their hands due to working from home and shelter-in-place restrictions and a general desire to hit the outdoors, “staycate” and indulge in activities that are, by definition, “social distancing.”

3. Pet-related companies (numerous) – the pet sector, which grew through the Great Recession, appears to be holding on well as our four-legged friends are afforded the same status as other members of the family, proving their health, livelihood and entertainment are on par with two-legged members. Pet product vendors and retailers (namely those with e-commerce capabilities) report good, if not very strong performance thus far. A conversation with a brick-and-mortar pet retailer with e-commerce capabilities reports challenges hiring large numbers of new warehouse workers to fulfill orders that are “going bonkers.” From a higher level, one need look no further for evidence of the durability of the pet/DTC space than Chewy’s stock price, up 3% in the last few weeks while the market is down 30%+.

4. Home fitness equipment manufacturer (100% DTC) – business is exceptionally strong, in particular, given social distancing, gym closures, etc. Ability to keep adequate inventory has been mitigated by ability to cost effectively overnight freight and given Chinese factories are back to full utilization. Additionally, ad spend (CPM, CPC) has declined significantly.

5. Traditional gaming company (board games, etc.) – as families hunker down and are “forced“ to interact more than normal, the demand for simpler, and in many respects “comforting“ entertainment (at least for those of us old enough to remember actually playing these games as youths) has increased.

6. Food manufacturer (serving Costco, Trader Joes, etc.) – demand remains very strong from grocery and club channels (the latter was described as “doubling down” on orders). Main concern is having enough factory workers to fulfill demand, “social distancing” on the factory floor (that can entail reworking line configurations) and obvious worker and/or factory equipment COVID19 infection and contamination.

7. Off-price retailer – while suffering from temporary store closures, this business expects to perform strongly in the near term as inventory presently sitting idle in non-off-price retailers will, in some instances, be viewed as “worth pennies on the dollar.” A natural escape hatch for this inventory will need to be off-price retailers who obviously have the customer base and importantly, the warehousing to accommodate.

8. “Retail healthcare” (numerous conversations with healthcare service providers with a consumer-facing angle) – depending on geographic location, the more discretionary the procedure or service, the more near-term deferrals (distinct from a cancellation), based on shelter-in-place mandates, local demographics (e.g., age), etc. Centers for Medicare & Medicaid Services may begin requiring patients to forego any elective / non-essential procedures. Dermatology, dental, orthopedic, Lasik-focused vision and fertility are likely going to take near-term hits (but will likely rebound quickly from “deferred treatment”). Instances of discretionary patients not wanting to leave home and/or go to a medical office now are balanced by telemedicine (providers with these capabilities are differentiated and faring well) and by the recognition of existing or looming shortages of personal protective equipment (which appears to be subsiding a bit). Non-acute retail healthcare services that are nonetheless viewed as mission critical and non-discretionary are clearly performing, but providers face many of the same health risks, albeit perhaps against a less urgent backdrop, as acute care medical professionals do.

MHT Partners, a leading consumer growth investment bank, will remain committed to providing thoughtful insight during this time of uncertainty and welcome further discussion (Craig Lawson, clawson@mhtpartners.com, Patrick Crocker, pcrocker@mhtpartners.com), Gavin Daniels, gdaniels@mhtpartners.com, Tara Smith, tsmith@mhtpartners.com, Tom Gotsch, tgotsch@mhtpartners.com).

Coronavirus Impact on Healthcare Investing

As the World Health Organization officially declares a pandemic and global capital markets gyrate, it’s easy to imagine scenarios where healthcare investing grinds to a halt as financial professionals and industry experts recalibrate their expectations for growth in the sector. Without trivializing the risk to the public and the real financial impact of the recent coronavirus outbreak, it is MHT Partners’ perspective that the healthcare sector is positioned to weather the storm.

A significant portion of healthcare expenditures can be described as non-discretionary. Many groups can expect to see similar or increased patient volumes as people’s concerns about their wellbeing are heightened by the uncertainty created by the spread of the coronavirus. Specifically, groups within narrow networks, managed care organizations, lab and diagnostic businesses and products and services geared towards enhanced communication or collaboration could see a significant uptick in their businesses as the need for coordinated care becomes even more important in response to this public health crisis. Notably, this week the U.S. Senate approved an $8.3 billion bill targeting the coronavirus, thereby removing certain restrictions on how, when and where healthcare providers can use telehealth technology. Several of our clients with telehealth solutions in place have already been able to transition patients from in-person visits to online consultations. These capabilities are true differentiators; the return on investment for telehealth infrastructure is already “penciling out” in many cases.

More broadly speaking, we have observed that the markets for leveraged finance are functioning. PE groups and lenders will need to continue to collaborate to make sure that businesses have enough capital to continue to execute their plans – which includes M&A as a driver of growth. While things may be moving a bit more slowly, we also expect that the market rebalancing we’re experiencing will create more “buy” opportunities for groups that have been struggling to deploy capital at near historic valuation levels. With nearly $1 trillion in dry powder being held collectively by U.S.-based private equity and private credit funds, the need to deploy capital should help stoke demand despite the macro headwinds businesses are facing.

From a returns’ perspective, the healthcare sector presents a host of attractive opportunities. According to the widely cited annual “Global Healthcare Private Equity and Corporate M&A Report” published this week by Bain & Co., healthcare investments made during the last recession had a multiple on invested capital that was close to 50 percent higher than other industries (2.7x vs. 1.8x).

It will be some time before the dust settles, but from MHT’s perspective, healthcare remains a viable category for continued investing both in the near-term and long-term.

MHT Partners’ healthcare team welcomes further discussion: Taylor Curtis (tcurtis@mhtpartners.com) or Alex Sauter (asauter@mhtpartners.com).

Consumer Purchasing Metamorphosis: How Consumer Purchasing Data is Shaping Loyalty Solutions

Today’s businesses face increasingly competitive dynamics in brand loyalty as consumer preferences become more demanding and less forgiving. Companies traditionally relied on a one-size-fits-all approach to attracting and retaining loyal customers. However, businesses are now adopting a personalized, targeted, and multi-channel approach throughout the entire consumer lifecycle. Payment platforms, in combination with tech-enabled engagement and marketing solutions, continue to emerge as a more attractive option to create experiential success for consumers through the use of artificial intelligence (“AI”), machine learning, and data analytics, which has driven M&A interest and activity in the space.

Harvard Business Review’s, ‘The Value of Keeping the Right Customers,’ illustrates how increasing customer retention by 5% increases profits from 25% to 95%(1). The question is, what is the best way to incent consumer loyalty? Companies historically targeted repeat customers through a standardized marketing program. Consumers received mass-produced marketing material and participated in transactional rewards programs that offered little in terms of customization. While this approach has been successful in the past, brands have begun developing a more personalized, experiential approach to consumer loyalty. The use of tech-enabled engagement and marketing solutions in the rewards space has allowed companies to identify consumer trends at an individual level and build on consumer loyalty. Data analytics, in combination with AI and machine learning, allow companies to thoroughly analyze each consumer transaction and predict relevant product recommendations. Engagement and marketing platforms use consumer data to calculate metrics such as recency, frequency, and spend of each customer in addition to projected churn rate and customer lifetime value. This allows companies to understand what is driving behavior at the individual level and use successful engagements as a basis for increasing consumer loyalty. But where is this consumer data coming from?

Data gathered from a consumer’s purchases offers brands the opportunity to obtain deep insight into that customer’s habits and trends. The data captured through the payment process allows marketers to develop unique, individualized actions aimed at improving customer relationships and maximizing the potential of future interactions. Mastercard has been an early adopter of utilizing its payment data in conjunction with tech-enabled loyalty solutions to offer data-driven insights to retailers and other consumer brands. Mastercard has made a number of investments in the space to enhance its solutions’ offerings, from its acquisition of Applied Predictive Technologies, a test and learn analytics tool for brand loyalty, to its recent acquisition in October 2019 of SessionM, a SaaS platform for customer engagement and marketing.(2)   Information gathered from the payment process lays the framework for tech-enabled engagement and marketing companies to deliver advanced insight into consumer spending and personalized solutions for consumer loyalty.

In addition to facilitating an individualized experience for consumers, the combination of payment and tech-enabled engagement and marketing platforms helps to curate the unique experience across multiple facets of the product purchase cycle. Companies with strong omnichannel customer engagement strategies retain 89% of existing customers, as opposed to a 33% retention rate for companies failing to embrace these strategies(3).  Payment platforms provide another channel of insight into consumer loyalty by analyzing purchasing habits and using the data collected to deploy targeted interactions that incentivize consumers at various stages in the sales process. The acquisition of Honey by PayPal for $4 billion in November 2019 illustrates continued investment by payment platforms in omnichannel engagement and marketing solutions(4). Instead of solely targeting customers during checkout, PayPal will now leverage Honey’s product discovery, price tracking, offers and loyalty solutions to interact with consumers across multiple touch points and earlier in the deal discovery process.

MHT, a leading technology investment bank, will continue to follow consumer loyalty trends as investment in engagement and marketing software remains an increasingly beneficial option for companies looking to maintain high growth and expand into new services. To learn more about MHT, please contact Mike McGill (mmcgill@mhtpartners.com) or Kevin Jolley (kjolley@mhtpartners.com).

(1) https://hbr.org/2014/10/the-value-of-keeping-the-right-customers
(2) https://newsroom.mastercard.com/press-releases/mastercard-acquires-sessionm-to-broaden-its-merchant-loyalty-marketing-services/
(3) https://www.digitalcommerce360.com/2013/12/31/why-omnichannel-strategy-matters/
(4) https://investor.paypal-corp.com/news-releases/news-release-details/paypal-acquire-honey

Review of Global Pet Expo 2020

I recently attended Global Pet Expo and came away with the following thoughts and observations.

Overall, the show was slloooow. Traffic was down significantly, palpably, depending on your location on the floor, due to, not surprisingly, coronavirus fears (yes, there was some bad weather in the Midwest as well, but that was not the main issue). Not only was the section of the floor typically reserved for Chinese vendors completely unoccupied, but several, notable large retailers (spanning the spectrum of channels) had smaller-to-nonexistent contingents at the show as well.

Over and above the aforementioned, certain themes continue to play out. In the consumables category, raw, dehydrated, and to a lesser extent, supplements, continue to garner a lot of attention. On the supplement front, while the cannabidiol (“CBD”) element was certainly present, I felt it was less so than last year (where it was almost ubiquitous). Dilated cardiomyopathy (“DCM”) continues to be a topic of discussion though less so as the year anniversary approaches and comps lap. On the durable side, as is the case every year, evolutionary change continues to manifest, though nothing of “revolutionary” nature.

Additionally, in the midst of a week of tremendous stock market volatility, a certain “macro” calm did exist at the show given the “recession resistant” status of the pet sector….the economy will go up and down, the stock market will go up and down, but Buddy will continue to get his toys and treats every day.

MHT Partners, a leading consumer growth investment bank, will remain highly active in the pet space and would welcome a conversation with you (Craig Lawson, clawson@mhtpartners.com).