Published January 2021
While the market presents an opportune time for M&A transactions and growth equity deals, companies will need to consider whether their financials are in a good position to make the most of the opportunity. One of the main factors is, what we call, The Revenue Question.
Before diving into what this entails, we want to emphasize that the general state of the markets is favorable. After a pandemic-led pause on M&A activities, deal volume rebounded considerably towards the end of 2020. Five of the largest deals were announced in the last four months of the year; the largest was S&P Global’s purchase of IHS Markit for $43.5 billion at a rich 24x trailing EBITDA. SPAC proceeds grew by almost 80% in the fourth quarter, ending the year with $83 billion raised. With stock markets recovering quickly to reach all-time-highs (again) and a vaccine-driven economic recovery on the horizons, investor sentiment is ripe as companies start to think about deal execution.
Diving into the Revenue Question
Companies with strong or stable revenues are in a favorable position to execute a deal, especially if annual revenue is up from 2019. Those companies in sectors such as enterprise software, ecommerce, and FinTech (some areas) tend to be in this category. Other companies that show positive signs of recovery in 4Q:2020 revenue (year-over-year) can also consider moving forward on deals but should take seasonality into account.
On the other hand, companies whose quarterly revenue declined against 2019 should put deals on hold, pending a more sustainable recovery. During difficult times, buyers and investors tend to discount weak revenue growth to a degree, especially for businesses that have recurring revenue. Companies can cash in on this “COVID Credit” later in the year, as economic activity starts to rebound to prior levels, charting a path for financials to recover. To protect themselves, more buyers are incorporating post-closing adjustment mechanics that consider cash holdings, debt levels, working capital, and other dispute resolution features.
There is a caveat for companies that are highly dependent on heavily affected sectors such as oil & gas and airlines / travel. The task ahead remains daunting for these companies, with a vaccine-driven recovery relatively uncertain.
DoorDash, one of the largest IPOs of 2020, raised $3.4 billion despite being wildly unprofitable. For companies that not only record high revenue growth, but also take in high profits as a leading player in a niche area, a high valuation multiple can be more easily justified. One of Evolve’s contacts received a strong multiple by specializing in clinical and financial management software for ambulatory surgery centers (ASCs) – modern healthcare facilities that provide surgical services that do not require hospital admission.
Crystal Ball for Deal-making
Insurance: The industry has held up reasonably well, benefitting from healthy balance sheets. Health insurers have posted enormous gains, with United Health Care and Anthem reportedly doubling their 2Q profits as compared to the same period in the prior year. Property & casualty insurers were directly impacted by COVID-related losses, but years of increasing rates, restricting capacity, and tightening conditions (i.e., “hardening market”) have made the sector fairly resilient to the most adverse effects of the pandemic.
Trean Insurance Group, a provider of casualty and workers compensation insurance, went public in July 2020 when the pandemic was in full swing. The company had a 7.1x revenue multiple on a $767 million market value at listing date.
Baldwin Risk Partner, an insurance distribution firm, completed its IPO in June 2020 at an enterprise value of $2.8 billion, 9.7x its revenue.
In Early 2020, Aon announced its intention to acquire Willis Towers Watson for $30 billion, the largest ever acquisition in the sector’s history. The combined entity is set to be the world’s largest insurance broker.
Vertical Software: Software providers that specialize in sectors that were not heavily impacted are highly sought after by traditional PE investors, especially those that provide mission-critical software. As SaaS grew and matured over the past decade, every industry is now running on software. Each industry is demanding more specialized features, as seen in the rise of InsurTech, HealthcareTech and PropTech firms in recent years.
For instance, there is growing appetite for deals in the InsurTech space, as players seek to gain market share. PE-backed Vertafore was bought by Roper Technologies for $5.4 billion, while Majesco was taken up by PE firm Thoma Bravo in a $729 million deal. Brown & Brown acquired CoverHound, a digital insurance marketplace in November 2020.
Notable IPOs for 2020 include GoHealth and Accolade (HealthcareTech), Root Insurance and Lemonade (InsurTech) and Rocket Companies (MortgageTech / PropTech).
Momentum for vertical software companies will likely continue in 2021, driven by the pandemic push to accelerate digital transformation. Firms that can master the SaaS model to generate high recurring revenues would continue to garner high interest of markets and investors.
Securities / WealthTech: Persistent qualitive easing and the Federal Reserve’s asset purchase programs have pushed up equity prices, generating high fees and returns for the industry. Furthermore, retail traders have flooded the market, driven by the Work-from-Home extension and the convenience of online brokerages.
On the political front, Joe Biden’s electoral victory has boosted prospects for a sizeable stimulus deal, which can only be favorable for equity markets. In the previous stimulus round last year, stock trading was one of the most common uses of the money.  In addition, despite Democrats regaining the Senate, the political body remains split 50-50, which will make it harder for the administration to pass heavy financial regulations. This bodes well for the financial industry in the coming years.
Morgan Stanley acquired investment management firm Eaton Vance in October 2020 for $7 billion, translating to an EV value of 17.5x forward 12-month earnings. Revenue multiple will likely remain strong for the year, buoyed by political, economic and social trends.
Lending: FinTech lending is facing a more challenging situation, as the sector undergoes a K-shaped recovery. In late 2020, P2P lending pioneer LendingClub announced a pivot away from its business model to focus on banking products. This follows the exit of US-listed firms Lufax and Weidai from the space in recent years, highlighting the difficulties of the business model: thin margins at relatively high risk, as the situation worsened during the pandemic crisis.
Kabbage was sold to AMEX at a sizeable discount of $850 million, compared to the previous valuation of $1.2 billion, which foreshadowed difficult times to come for businesses with similar models.
There remain bright spots in the industry, notably the Buy-now Pay-Later (BNPL) sector. Retailers have welcomed the use of BNPL services to attract younger shoppers, especially during the holiday season in late 2020.
Earlier this month, BNPL company Affirm went public at $12 billion, several times higher than its $2.9 billion valuation in a 2019 round. Stock price of the company went on to ‘pop’ on the first day, which caused the firm’s value to double to $24 billion.
AI lending firm Upstart, which leverages machine learning to automate the borrowing process and to price credit, also went public recently. At a $1.5 billion EV, the revenue multiple is about 7x.
Companies that want to take advantage of the vaccine-driven recovery, or to cash in on the “COVID Credit” would do well to start engaging with relevant investment banking firms, especially since it can take up to a year to close a deal. Those that have been performing well financially may even want to kickstart the execution. However, companies will also need to consider several factors, especially potential industry-specific headwinds in the coming year.
For most of us, the worst is likely over, as tech-enabled business providers take advantage of strong technological adoption post-COVID, and most companies stand to benefit from the release of pent-up demand for goods and services.