Commercial due diligence: Adapting to the new landscape

"In mid-March, everything changed overnight," says Jon Whiteman, a UK-based partner at independent CDD firm CIL. "Between January and March in the UK, deal activity was at very high levels following another period of uncertainty linked to the general election. Now, the market is at 20% of the previous deal activity, and we are expecting suppressed volumes for some time."

His take on the sudden drop in activity in March, when the UK suddenly entered lockdown following a period of uncertainty and while the rest of Europe was already coming to a standstill, sums up the view of a variety of UK players across the advisory and investment communities.

Over in Germany, Clemens Beickler, who founded CDD boutique Codex Partners 20 years ago, says his firm's pipeline has definitely changed: "Larger deals, which are mostly driven by the investment banks, have all but evaporated. Processes started in Q1 are becoming a lot more unsure and stretched further down. But deal activity is still going on, especially in sectors like IT – albeit not at a level that is satisfactory for us, of course."

Regardless of the precise point at which M&A processes ground to a near halt – which was obviously staggered between the early days of Italy, all the way to the slightly delayed reaction of the UK – the impact was eventually the same for PE-focused advisers. The first three weeks post-lockdown were all about focusing on portfolios, and virtually everything deal-related was paused. PE owners were squarely focused on trying to address three key questions: what is the extent of the impact, what is the plan for dealing with it, and are management teams actually implementing that plan successfully.

The fact that live deals were paused indefinitely in these first few weeks was obviously grim news for the transactional-driven part of CDD advisers' business models. "If it was early-stage vendor due diligence (VDD), we did progress on doing the market analysis work – these deals take time in any case, and the thinking was that if this was all sorted by July, then deals would just resume," says Whiteman. "Everybody is now conscious that timings will most likely slip further."

Mother of invention
Nevertheless, CDD players – like the investors they advise – have had to find ways to make the most of the limited opportunities still popping up in that first phase of the Covid-19 crisis. And sentiment started improving markedly from early May, as some PE players regained their footing and the prospect of lockdowns easing got some processes moving again.

Tom Raymond, a director at Armstrong, distinguishes the impact on his firm's pipeline from the quantity and quality points of view. "Quantity-wise, dealflow is down across the market as a whole by about 80%, but Armstrong is operating close to capacity currently, all of which is CDD on new deals," he says. "We did experience a 40-50% activity dip in April during the initial Covid-19 response, when PE teams were focused entirely on portfolios, but that time has passed. On the quality side, CDD is becoming comparatively more important because of the downside risk to any transaction. So we are seeing a shift away from transaction-friendly VDD, that doesn't challenge the business but gets the deal done, and towards the rigorous and constructive sort of work that was done during and after the global financial crisis (GFC). The questions from PE players are getting very specific; they're really on top of the investment hypothesis and are figuring out all the potential angles."

Larger deals, which are mostly driven by the investment banks, have all but evaporated" – Clemens Beickler, Codex Partners

Whiteman also highlights that PE players are now getting more bullish in looking at what investment opportunities are out there, albeit with a different mindset: "PE firms moved from proactively chasing deals, to portfolio triage at the beginning of lockdown, but have since moved to planning for the future and where investment opportunities might be found post-Covid-19. They are conscious they will need to be more creative, including looking at take-privates (but some think the markets are still overpriced so there may not be such a rush to that just yet). We are seeing a few more pre-emptive approaches, although processes are still likely to be affected for a while from a practical standpoint. There is also going to be a lot more bolt-on activity compared with historical levels. It is much easier to put money into a market you already know – going to investment committees with something new at the moment can be pretty challenging."

While there is clearly work to be done, CDD advisers have also had to adapt to a new way of interacting with sponsors and management teams. The consensus is that, while remote working has not necessarily been optimal, video tools and a greater reliance on technology even prior to the outbreak have allowed processes to progress despite the circumstances. "We had a virtual kick-off meeting with a management team and the PE house last week and it worked fine," says Whiteman, with Raymond adding: "Meeting management teams for the first time via video call is not ideal. You lose the subtle dynamic between people, the ability to read body language when not in the same room. But, at the same time, a lot of people have got more time to discuss long-term thinking and strategies."

Out of sight
The picture is equally mixed when it comes to business development, which understandably is becoming a key concern as firms keep an eye on their bottom lines in extraordinarily challenging times. The complete lack of trade conferences in the medium term is likely to have more of an impact on big-volume players, whereas the independent players Unquote spoke to are less concerned about the inability to harvest stacks of business cards. "This is not really a big deal at all for us, as we are not focused on volume – we don't have to do 250+ deals a year to keep the lights on," says Raymond.

Nevertheless, the market remains tough for all advisers, as Beickler highlights: "Winning new clients via Zoom or Teams is certainly not easy." But he also adds that, while there is clearly a lot of portfolio activity by GPs going on, discussions tend to be "very constructive" when they do happen. "There is a shared feeling, I think, as we are all affected in the same way at a very personal level. It creates a sense of common ground."

His comments are echoed by Whiteman: "On the business development side, this is yet to fully play out. The first few weeks were really focused on reassuring existing clients, so it wasn't too much of an issue. It is more challenging for developing new relationships, but everyone soon realised they were in the same boat, so you can still get through." He adds that CIL has still managed to talk with 130 PE houses worldwide since the start of the pandemic.

Whiteman also points out that this could end up reshaping the way advisers and sponsors develop relationships, with the US market showing that a lack of in-person interaction can be worked around: "It is much more spread out, not concentrated around one or two major cities like it can be in European countries, so everyone is used to working remotely. This is transferring across to the UK right now."

Knowledge-sharing has also been a key way to initiate and maintain relationships. A number of advisers have taken to social media and email campaigns in earnest, generating more thought-leadership pieces with practical advice for key sectors, or sharing relevant data and surveys with the wider community. These efforts are likely to last for some time, although Whiteman cautions against reports fatigue: "You want to show you are thinking ahead, but also you don't want to overload with too much information (or do it too early as well, since the situation is evolving so rapidly)."

We are seeing a shift away from transaction-friendly VDD, that doesn't challenge the business but gets the deal done, and towards the rigorous and constructive sort of work that was done during and after the GFC" – Tom Raymond, Armstrong

Looking to the future
The ability to look beyond the first phase of the pandemic, and rethink what CDD will look like in the next cycle, is indeed becoming a crucial pivot point for specialist players. "The first mitigation measures were all about 'cash is king'. Managers that saw the GFC knew what to do, and this was managed pretty well overall," says Beickler. "Now the focus is shifting to restructuring. It will have to be done, because this crisis will go on for some time – some businesses will be hit very hard, others will have to adapt. The big question is really: how can portfolio companies manage the crisis successfully and emerge from it stronger than competitors. Strategy has to drive restructuring."

The fundamentals of "bread and butter" CDD work are unlikely to profoundly change because of the current situation, even though execution is now much trickier, says Beickler: "You basically aim to answer three questions when it comes to CDD: why has the company been a success, will it continue to be successful, and what increase in value can the deal bring. Covid-19 still requires these three questions to be answered, and it is a challenge to do so for many companies at this stage."

But the CDD advisers Unquote spoke to were also unanimous in pointing out that – following the approach undertaken by a number of their PE clients – long-term strategic plays are gaining much more prominence in their pipeline now that the rush to find and complete new deals has come to a halt. "People don't want to come out of this period not knowing what to do, so we have been doing a lot of market mapping work, to identify what processes could come back and which sectors will make attractive investment areas," says Whiteman.

"We also have long-running platform projects, where we have ongoing activity with company owners and financial sponsors," says Beickler. "Some company owners have become more open to talks about equity partnering as the unexpected shock from Covid-19 has increased the awareness of business risk."

Raymond adds that a significant proportion of Armstrong's current work is not transaction-specific, but working directly with PE houses: "This covers exploring mega-trends, revising investment hypotheses in light of Covid-19, analysing specific sub-sectors, and then screening for future companies to approach – target identification, basically. This is work that can be really valuable in a downturn, as evidenced when you look at the high returns of fund vintages that invested around 2010. It will also shift investors' strategies in a big way, especially for newcomers – the identification of newly attractive sectors, that will benefit long-term from profound changes in the way businesses work, will become a key theme."

You know the drill
The current crisis – and especially the first phase of dealing with a sudden shutdown of business activity – is also likely to leave its mark on company-specific CDD for years to come, too. A fan chart has for a long time been a staple of CDD work, including a "2009 GFC" scenario. It is now very likely that such analyses will now incorporate a coronavirus scenario as standard.

"Looking at resilience has always been a key feature of CDD work," says Beickler. "Look at the 2008-2009 crisis, for instance: that has remained a staple in the past decade, in terms of specifically looking at how businesses were affected, for how long, etc. But this crisis will certainly make its mark and people will always look back at 2020 to see how businesses navigated that challenge."

Beyond checking a company and a management team's track record during this defining event, Whiteman also expects to see some more aggressive demand-side analysis in future work. "More generally, people will want to look at supply chains and workforce resilience," he says. "In the longer-term, investors could be more cautious in how they approach certain sectors, even those that have traditionally been seen as less cyclical – resilience will become a point of focus across the board. But PE is by nature flexible and entrepreneurial, they will find ways to put that money to work."

Most active CDD players in 12 months to 11 May 2020 (by aggregate value of deals)

Rank	Firm	Value (€m)	Volume
1	Oliver Wyman & Company	24,605	9
2	Roland Berger	9,875	85
3	Bain & Company	7,060	35
4	Boston Consulting Group	6,697	26
5	McKinsey & Co	6,241	14
6	EY	3,575	34
7	LEK Consulting	2,944	23
8	Barclays	2,798	1
9	Arthur D Little	2,658	6
10	PwC	2,312	37
11	Advancy Consulting	2,017	5
12	Indefi	1,619	20
13	Teneo	1,300	1
14	Rautenberg Moritz & Co	1,200	3
15	KPMG	1,062	13
16	RPL	1,006	5
17	Eight Advisory	950	2
18	Kearney	905	5
19	CIL	846	24
20	Candesic	834	11

Source: Mergermarket

Most active CDD players in 12 months to 11 May 2020 (by volume of deals)

Rank	Firm	Volume	Value (€m)
1	Roland Berger	85	9,875
2	PwC	37	2,312
3	Bain & Company	35	7,060
4	EY	34	3,575
5	Boston Consulting Group	26	6,697
6	CIL	24	846
7	LEK Consulting	23	2,944
8	Goetzpartners	21	702
9	Indefi	20	1,619
10	Advention Business Partners	16	145
11	Armstrong Transaction Services	16	22
12	McKinsey & Co	14	6,241
13	KPMG	13	1,062
14	Codex Partners	13	256
15	Candesic	11	834
16	Neovian Partners	11	534
17	Oliver Wyman & Company	9	24,605
18	Catalysis Advisory	9	29
19	Deloitte	8	146
20	Fairgrove Partners	8	3

Source: Mergermarket

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