Despite the downturn in the economy, the multiples paid for businesses in 2020 remained relatively stable – how so?
The Coronavirus pandemic and subsequent lockdown in the UK and across the world heavily impacted most industries; for some, the full impact is yet to emerge and is difficult to forecast. Mergers and acquisitions (M&A) activity in the second quarter of 2020 on a global scale was dramatically affected, with deal volume almost halving from 4,308 deals in Q1 2020 to 2,630 in Q2 2020 with deal value dropping proportionally.
Despite the marked downturn of UK M&A activity in Q2, deal volumes began to recover in the third quarter and the year finished with exceptional levels of activity. The multiples paid for businesses in 2020 remained relatively stable.
Deal values tend to be derived using a multiple of a company’s sustainable earnings, usually reflecting recent trading or a forecast view of trading. These multiples are applied to a company’s EBITDA (Earnings Before Interest, Tax, Depreciation and Amortisation), which also equates to a multiple applied to the company’s revenue. This results in the company’s ‘Enterprise Value’.
According to MarktoMarket’s All-Cap index, the median EBITDA multiple paid in transactions valued under £250m in 2020 was 9.2x, which is the same as 2019. However, multiples differ across industries and deal sizes therefore it may be more accurate to look at the multiples paid on an industry-by-industry and size-by-size basis.
This is particularly prevalent when looking at multiples paid for transactions during the pandemic as economic performance varied wildly across different industries. Deals in TMT (Technology, Media & Telecommunications), Healthcare and Financial Services all increased their percentage share of total deals compared to previous years. These tend to be higher multiple sectors and are likely to have pushed the All-Cap multiple higher.
Multiples paid in deals involving targets from the Industrials & Business Support Services, TMT and Financial services sectors saw an increase despite the Covid-induced recession. TMT attracted the highest multiple at 11.4x EBITDA, as technology businesses remained robust in trading and valuations. Software companies are also included in this sector whose products and services were in demand as many companies told their employees to work from home. IT and telecommunication adoption is estimated to have grown 1.2% in 2020-21.
Unsurprisingly, deals involving companies in the consumer goods sector saw the largest decline in multiple paid, falling 35% year-on-year. Revenue in the retail clothing industry is expected to fall 32.4% in the current year due to the closure of non-essential shops. Larger multiples were awarded to exclusively online brands as they benefitted from the closure of bricks and mortar retail, seeing a forecast increase of 37.5% in the current year.
Perhaps surprisingly, multiples paid for Healthcare companies fell by 13% in 2020 compared to 2019 due to a large number of deals in healthcare services-related areas like occupational health and general practice, which tend to attract lower multiples. The pandemic weighed on industry revenue in the Allied Health-Care Services industry, with revenue forecast to fall by 7% in 2020-21 due to non-essential medical care services being partially suspended at the beginning of 2020.
In contrast, revenue in the Biotechnology industry is anticipated to grow by 6% in 2020-21 as demand for human health products surged for companies researching and developing antibody testing kits and vaccines. However, many transactions involving biotechnology companies are not valued based on a traditional EBITDA multiple approach as they tend to be early stage and IP rich, with little revenue and profitability. They have therefore been excluded from MarktoMarket analysis.
There was also a greater proportion of deals completed between £50m and £250m than in previous years. Higher multiples tend to be paid for larger companies; therefore, this is also likely to have pushed the All-Cap multiple higher. The multiples paid for deals valued under £10m experienced a significant decline, with multiples paid for transactions between £2.5m and £10m down 12% year-on-year.
It’s worth noting there is potential for data at this end of the spectrum to be misleading, as most companies are owner-managed businesses and therefore EBITDA can be artificially depleted/inflated dependent on directors remuneration.
Multiples paid for deals valued above £50m also experienced a significant decline, with multiples for deals valued above £250m decreasing by 35%. In contrast, deals in the ‘lower mid-market’ which are valued between £10m and £50m and seen as the most indicative of the health of UK M&A, experienced a 6% expansion in multiple paid.
Multiples paid for acquisitions valued between £10m and £50m, which is perhaps the most reflective of the health of UK M&A, saw an expansion, in comparison to other deal sizes which saw a retraction. Companies in the Industrial & Business Support Services, TMT and Financial Services saw an increase in multiples paid, whereas multiples paid for companies within the Consumer Goods sector saw a significant reduction. This was largely in tandem with industry performance over the year.
Looking at 2021, M&A activity in the first quarter has shown exceptional levels as pent-up demand from suppressed deal volumes in 2020 and fears of changes to the capital gains tax regime encouraged deals to complete. However, multiples have still not recovered to pre-Covid levels. The recovery in deal volume has provided optimism amongst dealmakers for 2021 as the roll-out of multiple vaccines facilitates a return to normality for society.
PEM have valued and advised on the sales of many businesses across a wide range of industries. Some examples are highlighted on our Deals page. Get in touch with the PEM Business Valuations team to discuss your business valuation requirements or learn more about our process for valuing businesses.