DealMakers AFRICA Q2 2020
Deal levels collapse as COVID-19 disrupts global market
by Nick Lazanakis and Guy Steele
As expected, Q2 2020 saw the lowest level of mid-market M&A deal activity in decades with deal volume plummeting by 63.4% compared with Q2 2019. As COVID-19 has spread rapidly across the globe, most economies are facing lockdowns and restrictions on movement, which have resulted in enormous disruption in supply chains, cashflow issues and funding gaps. The consequence is that business owners and managers are focusing on managing their core business and its recovery and as a result inorganic M&A activity has taken a back seat.
There were just 15 mid-market deals completed during Q2 2020 across Africa, worth a total of US$863 million. This represented a decline of 18.3% from Q1 2020 (US$1,06 billion), which already represented the worst levels recorded since the Global Financial Crisis of 2008.
In our view, the deal paralysis in Q2 2020 was a combination of two major factors:
From a new deal perspective, there was limited activity as a result of companies focusing on survival and concerns over the timing of going to market. Many companies immediately announced a freeze on major capital expenditure and acquisitions; and
In deals which started pre-COVID-19, we have seen, in some instances, a power struggle taking place in relation to pricing with bidders looking for ‘bargains’ and sellers not willing to take significant ‘haircuts’ on prices. In some cases, we have seen parties invoke ‘Force majeure’ on concluded deals in order to return to the negotiating table.
Key deals and sectors
Africa was one of the last continents to fall victim to the exponential spike in COVID-19 cases, so the region is lagging behind the rest of the world in this respect. This, coupled with reduced investor confidence in many territories, a slowdown in economic activity and the increased pressure on the ease of doing business, meant that deal volumes experienced their fifth consecutive quarterly fall to just 15 deals with a value of US$863 million in Q2 2020.
Notably, force majeure and Material Adverse Change (MAC) clauses have become a key mechanism in the markets’ attempt to cancel or renegotiate announced deals. In Horizons issue 2 of 2020, we reported on the quarter’s biggest deal, namely Barloworld’s acquisition of Tongaat Hulett’s starch division. This transaction is currently in dispute with Barloworld claiming a MAC event and independent experts are in the process of being appointed to adjudicate on the matter.
There was just one PE deal transacted in the quarter but we believe that this was partly due to a ‘wait and see’ approach by PE firms as well as an impasse on pricing between parties. We also believe that the pricing gap is narrowing but we still see a potential requirement for earn-outs and other deferred payment mechanisms in the medium term.
Another equally concerning factor is that at least three of the 14 remaining deals in the quarter are considered as forced sales, having been driven by large-scale irregularities and pressures at the parent company.
During the quarter, Egypt and South Africa (including Swaziland), with five deals each, maintained their positions as the continent’s most active M&A sectors.
The quarter’s largest deal by value was the acquisition of Atlantic Leaf Properties Limited by Apollo Global Management, Inc. (APO) for an aggregate cash consideration of approximately US$185 million or US$1.00 per Atlantic Leaf share. Explaining the rationale for the deal, Paul Leaf-Wright, CEO of Atlantic Leaf Properties, said that a “challenging environment in both South Africa and the United Kingdom has seen continued market uncertainty, particularly surrounding Brexit and more recently the COVID-19 pandemic. Limited support for capital raises and reduced liquidity has put pressure on Atlantic Leaf’s share price, which in turn has made it uneconomic to raise new capital to fund portfolio growth.” Peter Bacon, Chairman of Atlantic Leaf Properties, commented: “The Apollo Funds will bring a sizeable capital base, access to captive funding, execution resources and deep experience of investing in real estate portfolios, all which will contribute towards improved performance during uncertain times.”
Industrials & Chemicals and Consumer led the charge in the quarter’s sector deal activity with three and four deals respectively, emphasising the drive in foreign investment into renewable energy projects and the desire for industry leaders to obtain consumer-driven products in the healthcare sector (with Pharma chain 19011 acquiring 100% of Roshdy Group, a pharmacy group based in Egypt), babycare (with Dis-Chem Pharmacies’ acquisition of the Baby City Group) and food production and security (with the acquisition of the Egyptian Starch and Glucose Company (ESGC) by Cairo 3A by way of a mandatory offer to shareholders and Zeder Investments’ sale of its 32.1% stake in Quantum Foods Holdings to Country Bird Holdings).
Market environment and outlook
With the cautious approach currently being adopted by PE firms, even those with access to a wealth of dry powder, wide scaled retrenchments across the continent, depreciating and volatile currencies, IMF bailouts and the lack of sufficient reserves to support the various industries in need, the outlook for the continent is bleak.
Mid-market businesses are faced with the challenges of determining what new normalised earnings will look like, with sellers verging on the edge of overly optimistic forecasts, and buyers offering up to 50% of pre-COVID prices. The major banks operating in Sub-Saharan Africa are carefully monitoring their liquidity, with the unofficial consensus that large-scale, unsecured lending will not be undertaken in at least the short to medium term.
Conversely, industry leaders have stated that they are eagerly awaiting the various opportunities which will inevitably present themselves to those with sufficient strong balance sheets to survive the crisis.
Although the M&A market may have stagnated across the continent, good quality assets remain available in these trying times. As lockdown restrictions are lifted across Africa, a more optimistic view is emerging on sustainable earnings and what will constitute the new normal. Quality businesses will emerge from this period and we anticipate that the demand and interest for said quality assets will return, albeit at what cost?
According to the BDO Heat Chart, both the Industrials & Chemicals and Energy, Mining & Utilities sectors will remain active across the continent, followed by Consumer and Financial Services. With Energy, Mining & Utilities always being a primary driver of deal activity on the African continent, we anticipate foreign investment to continue into these sectors, considering the weakness of the emerging market currencies to the more established currencies.
With one of the continent’s giants, integrated chemicals and energy company Sasol, now fiercely trying to avoid a rights issue by embarking on a sell-off of noncore chemical assets, and the renewable energy sector attracting significant foreign investment from long-term investors, we anticipate the drive toward these sectors to remain a significant factor in the region’s future mid-market M&A activity.
Lazanakis is Head of Corporate Finance and Steele is Head of M&A at BDO, Johannesburg.
This article first appeared in Horizons Issue 3 2020, BDO’s Global view of mid-market deal activity.