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Company Valuations in a post-COVID Era
On the 23rd of March 2021, MarktoMarket hosted a webinar for over 260 attendees. The panel of Gavin Hood, Deloitte UK Head of Advisory in Scotland; Charlie Johnstone, a former partner at ECI Partners and Founder of Newlands Capital; Paul Jourdan, Co-Founder and CEO of Amati Global Investors; and Marktomarket CEO Doug Lawson discussed the impact of the pandemic on business valuations, and we are pleased to provide the highlights from that conversation below.
MarktoMarket CEO Doug Lawson introduced the webinar by referencing some of the findings from MarktoMarket’s latest M&A Valuation Indices release:
- The MarktoMarket All Cap Sub-£250m Index was stable in 2020 v 2019 at 9.2x EV/EBITDA
- The MarktoMarket Nano Cap Index fell from 6.4x EV/EBITDA in 2019 to 5.1x in 2020
- The MarktoMarket Small Cap Index expanded from 9.9x to 10.5x (2019 v 2020)
- The MarktoMarket Consumer Index fell heavily from 10.7x to 7.0x
- Conversely, the MarktoMarket Technology, Media & Telecoms (TMT) expanded from 10.4x to 11.4x
Doug summarised that the data implied that the risk premium increased for the smallest companies as investors preferred larger businesses perceived as more robust; and there was a significant variance in the fortunes of sectors.
Doug then turned to the panel and asked how advisers and investors have been able to settle on pricing assets in this environment
Gavin Hood responded first. A key question was whether they were appraising a new asset coming to market versus a deal which was in diligence where the multiple had already been determined and they were trying to understand the impact on the trading performance? Where you were having to determine the multiple you are not just looking at a snapshot of comparables. Instead, advisers will still be looking at comparables over a 2-5 year period as well as assessing the comparability of data points – for example, the scale, maturity, growth profiles and overall financial performance of the comps being used in order to get as close as possible to the circumstances in question. Putting this analysis to one side, advisers must also consider what the plan is for the business that is being acquired and, therefore, what price the buyer is willing to pay.
Regarding trading, the COVID environment brought into sharp focus the need to understand the ‘forecastability’ and quality of earnings.
You also have to recognise the underlying business revenue models and those businesses that showed the highest levels of resilience in 2020 typically commanded the highest multiples.
From an investor viewpoint, Charlie Johnstone reminded us that PE is “looking to have their cake and eat it” – they want to buy something with some predictability of revenues and underwrite a level of returns. In times of deep uncertainty that is harder but not impossible. PE deals were still done throughout the year. What Newlands tried to do was share the risk of future earnings with underlying vendors. They are seeing this more and more in structures through the use of ratchets and earnouts to balance risk between getting a deal done now and sharing risk about the future.
One example Charlie gave was £1m EBIT business with big growth expectations – he managed to agree terms by incorporating a ratchet to the team based on hitting future numbers. The vendor protected the downside but the team would benefit from the upside if they hit these numbers.
As a public equity investor, Paul Jourdan saw pricing move in real time. Doug asked how much of the movement in share prices was earnings-based and how much was based on the multiple contraction/expansion. Paul reminded everyone that it is hard to remember a year when prices moved from one extreme to the other to such an extent. One year ago the prevailing sentiment was panic – the market switches quickly to being a voting machine rather than a weighing machine. In other words, people vote quickly to move away from areas. In a market that is thundering down, you don’t necessarily make the right decisions. Valuations are very strongly driven by cashflow ie where is the cash moving. Since Rishi Sunak’s ‘whatever it takes’ announcement, the market has been driven by an extraordinary level of cash creation and, not surprisingly, valuations have gone up (they all have in Paul’s world). The market has also been talking about EBITDAC as a means to understand underlying earnings. The market also began to look through to the other side so understand what the business would look like – as a consequence, some consumer multiples looked crazy on a one year view but in the long term they were very cheap.
Further to Charlie’s comments on deal structuring, Doug asked whether the panel saw any other trends in deal structuring post-March 2020.
Gavin had expected this but, in the main, did not see this materialise. He saw some ratchets and earnouts being contemplated but invariably these were not enacted. However, there was a degree to which the types of businesses being transacted were demonstrating more resilience, with greater competitive interest which enabled vendors to resist earnouts.
Doug asked Charlie whether he expected structural changes in deal structuring or a return to pre-COVID practices. Charlie expects reversion to more standard structures. He used Capsule, a recent SaaS investment by Newlands, as an example. They were negotiating exclusivity in March 2020 and decided to pause to make sure they could enter exclusivity on a deal that could be delivered. There was some re-cutting of the deal and sharing of risk.
Notwithstanding some more shocks this year, it will be more straightforward to calculate a sustainable level of earnings and we will see fewer earnout structures. Charlie also mentioned that his previous role at ECI was investing in upper mid-market but now he is doing smaller deals where there is more perceived risk and therefore a greater chance of seeing earnouts.
Doug asked the panel where they saw ‘hot’ areas of the market post-COVID
Paul mentioned 4 themes:
- Pandemic beneficiaries – some were healthcare, and one in particular was referenced that was struggling at the beginning of 2020 but was the first to produce a CE marked COVID test and finished the year making multi-hundreds of millions of pounds of profit.
- Video games – benefitted from ‘stay at home environment’. They had already switched to online delivery so did not need retail for distribution. These stocks saw big re-ratings.
- Software companies allowing ‘working from home’ also saw big re-ratings.
- Energy transition companies – really took off through a retail-led phenomenon, possibly led by greater awareness of climate change.
Gavin saw similar themes to Paul. In consumer, there was a big impact but certain sub-sectors won, for example subscription-revenue, direct to consumer models. They also saw businesses in financial services (and fintech), healthcare and SaaS perform well.
Have valuations diverged between large and smaller companies?
Charlie felt like capital will shift to larger companies at times of economic distress and cited some examples. However, there is a reality where each PE investor will have a ‘collar and cap’ regarding investable universe. It is more about quality of revenue – subscriptions is the obvious one but there are others ways for advisers to evidence quality of revenue which will deliver better outcomes for their clients.
However, he conceded that there is more fragility and volatility with smaller companies so it is harder to capture all that value today.
Gavin observed that the overseas buyer population will typically only come in at a certain size level – an increased pool of buyers (and therefore competition) for assets with a larger scale and less volatility in earnings will usually result in relatively higher prices.
Why have valuations of high-growth technology companies fallen and have value stocks been beneficiaries?
Paul felt that valuations everywhere have gone up (with certain exceptions) but growth stocks have been driven up by expansive monetary policy. For the first time in many years, public markets are paying more than private markets for growth companies, which is attracting IPOs for Trustpilot, Deliveroo, etc. Expect this environment to carry on until we see interest rates change direction!
Are there any themes the panel expects to pan out over the course of 2021?
Charlie expects a continuation of a ‘flight to quality’ from private equity investors. He expects to continue to see ways to get comfortable with the quality of revenue for businesses beyond those with subscription models. It is too early for private equity to be investing in cyclical rebounds but this may change over the year depending on what happens with the end of lockdown. Cloud-based technologies will remain in favour.
In addition to ongoing private equity interest, Gavin is seeing well-funded trade acquirers in the market and would expect new areas of revenue growth and synergies to continue to be drivers. He can also conversely see opportunities in corporate carve-outs as companies reassess their areas of strategic focus
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