The COVID-19 pandemic has shuttered economies, disrupted supply chains, and generally caused a great deal of volatility and uncertainty in global capital markets, particularly for investors and companies trying to navigate the emerging landscape for mergers and acquisitions, IPOs, and other capital-intensive deals.
This week, in a new Reuters Newsmakers webinar, What Will Change? Deal-making in the Post-Pandemic Era, Thomson Reuters sponsored a forward-looking panel that discussed what deal-making, corporate governance, and shareholder activism might look like over the next year to 18 months. The panel was moderated by Rob Cox, editor of Reuters Breakingviews.
The “interim normal”
The abrupt and wide-ranging economic impacts of the COVID-19 pandemic have created a global guessing game about what is likely to happen and when, especially in regard to corporate behavior in the post-pandemic era and investor confidence in their strategies. Lauren Silva Laughlin, Global Deals Editor for Reuters Breakingviews, opened the discussion by asking the panelists what they thought Wall Street and the general corporate landscape would look like in the next year or two.
“I am hoping that six months from now we will begin to have a return to normalcy, and that we will be getting people back in the workplace, but on a relatively muted basis,” said panelist Leon Kalvaria, Chairman of the Institutional Clients Group at Citigroup. He refuses to think of this phase as a “new normal,” he said, preferring to use the term “interim normal,” which is part of the official lexicon that Citigroup has adopted when discussing the crisis.
The presumption is that at some point in the not-too-distant future, capital markets will sort themselves out as economic activity increases, companies adapt, and a clearer picture of the future emerges. But trying to predict what will happen tomorrow based on what has happened in the past is especially difficult now, the panelists agreed, because of the unprecedented speed and scope of the crisis.
“This has been a very unusual period,” Kalvaria said. “The capital markets have been robust, helped by the Fed, so there has been significant liquidity, which in turn has resulted in record issuance both in the investment-grade market and, more recently, in the non-investment-grade market.”
IPOs have not completely stopped, he said, but they have “morphed” toward IPOs that “work” in the current marketplace. He cited ongoing IPOs by Warner Music, several technology plays, and Blackrock’s $16 billion equity sale as recent transactions that have been positively received by the market. As for deal-making in general, however, Kalvaria thinks companies will be evaluating several factors over the next few months, including their financial capacity and strategic interests. But the most important factor, he added, is: “How do they re-forecast business in light of what is going on out there?”
Playing with certainty
One peculiar aspect of today’s economy is that despite widespread unemployment and business disruption, the stock market has steadied itself and is showing signs of optimism.
According to panelist Kristin DeClark, co-head of U.S. Equity Capital Markets at Barclays, the difference between the market’s performance during the 2008 financial crisis and now has been the Fed’s aggressiveness. “When you talk to the top institutional investors,” she said, “the real reason the market is trading where it is today is because you can’t short this market with the unprecedented amount of stimulus coming in.”
With their short-term risk reduced, investors are actually looking ahead to 2022, DeClark said, when a return to normalcy is expected. In fact, “May will be the largest month in equity and equity-linked issuance in history” with more than $70 billion in issuance in the month, she noted. The previous record was $64 billion in December 2009, in the wake of the 2008 financial crisis.
Panelist David Katz, a partner at Wachtell, Lipton, Rosen & Katz (WLRK), argued that going forward, the two most important factors in future deal-making will be “certainty of completion” and “valuation.” In short, buyers entering into deals will want to make sure they can close, and sellers will need to get comfortable with valuations that may fall short of their 52-week high. As they did in 2009, companies will try to mitigate risk by inserting contract clauses accounting for revenue shortages or other disruptions due to COVID-19, Katz said, warning that negotiating such clauses is “when deals often fall apart.”
Toward a more responsible capitalism
Another important but unpredictable factor in the post-pandemic corporate marketplace is the extent to which investors will embrace Environmental, Social & Governance (ESG) criteria, and how companies might respond, especially if shareholder activists get involved. For example, will investors reward companies that invest in the well-being of their employees and take measures to be more resilient and flexible, even if it means sacrificing some profit?
Citigroup’s Kalvaria is certainly hopeful that the COVID-19 crisis will encourage more conscientious corporate behavior. “We’re in a world now where people care about responsible capitalism,” he said. “Responsible means looking after your people and all your constituents. I think that companies that are viewed as slashing and burning will find that has a very negative impact both in terms of regulators and their customers and employee base.”
Katz of WLRK agreed, even suggesting that the entire ESG debate had changed because of COVID-19. “With unemployment where it is today, and assuming that it takes a while to get back to where we were pre-pandemic, I think that human-capital issues — paying people fairly, taking care of your employees, executive comp — those are all going to be front-burner issues,” Katz said.
According to Barclays’ DeClark, however, investors today are more interested in companies that are well-positioned to respond to changes in the economy that will persist beyond the pandemic. “Whether its workplace collaboration, security, gaming, fitness, eating out, food delivery, or e-commerce, investors are more focused on things that will have a benefit in the post-COVID world,” DeClark explained.
When the “post-COVID” world will come about and what it will look like are anyone’s guess at the moment, but all panelists agreed that one enormous factor will be the fractured relationship between the U.S. and China. Companies that pinned their growth strategies on China are going to be sorely disappointed, as M&A activity into and out of China has all but stopped. Furthermore, China is using the pandemic to move aggressively against Hong Kong, noted Katz, and in the absence of U.S. leadership, China is co-opting America’s traditional role as the benevolent “big brother” to other nations.
Much of what happens to corporations and capital markets in the coming year will depend on how long the COVID-19 crisis lasts, whether there are successive waves and lockdowns, and how the political situation in the U.S. unfolds pre- and post-election.
Despite the inherent unpredictability of all these events and more, panelists were nevertheless hopeful that some good will emerge from the COVID-19 crisis. Better healthcare, a more robust social safety net, more work flexibility, more responsible corporate governance, more innovative use of technology — all were floated as reasons to hope that the future may actually be a bit brighter than it looks at the moment.