Corporate Divestiture Plans Placed on Hold During Pandemic

The COVID-19 pandemic has slowed or stopped most every type of business transaction for the past five months. Nearly every industry’s M&A activity has been impacted by the coronavirus. And like many areas that were expected to surge in 2020, the corporate divestiture sector has been largely crippled due to the economic disturbance of the ongoing COVID-19 pandemic.

After a number of notable acquisitions and mergers of equals last year, a swell of divestitures was expected to be the fuel for 2020’s M&A engine as companies started to sell or spin off non-core business segments. However, as the coronavirus outbreak ground the global economy to a standstill, M&A activity slowed to a handful of deals that were in the works before the pandemic arrived.

Corporate Divestiture Activity Might Make A Comeback In 2020

The stifled divestiture activity could still come back this year. That’s according to Garrett Asta, senior vice president of Houlihan Lokey Inc.’s aerospace, defense and government practice who was interviewed in The Washington Business Journal.

“The long-term strategy remains the long-term strategy and there are tweaks to that,” he said. “It’s rare that nonstrategic assets all of a sudden do a 180 and become core strategic assets. So, it really becomes more of a matter of timing.”

Those strategies were lined up to be executed after 2019 saw the mergers of Harris Corp. and L3 Technologies Inc. to form L3Harris Technologies Inc. and Raytheon Corp. and United Technologies Corp. to form Raytheon Technologies Corp. Other companies such as Science Applications International Corp. and Northrop Grumman Corp. compiled large business segments with their acquisitions of companies Engility and Unisys Federal for the former and Orbital ATK for the latter.

As a result of those moves, observers believe that Raytheon, Northrop and L3Harris are likely planning to sell non-core business units that don’t align with their portfolio strategy. L3Harris executives recently commented that they are still planning to divest 8%-10% of their business portfolio in the next three years. At the same time, Perspecta Inc. could wind up either divesting assets or pursuing other businesses to scale, given recent activist investor activity in the company.

Some of those deals were already been completed before the pandemic. For example, Leidos Holdings Inc. acquired L3Harris’ security detection and automation businesses in February 2020 for $1 billion. Also, SAIC recently sold Engility’s international development services portfolio to form the privately held Sincerus Global Solutions, Inc.

However, as with other industries, the pandemic has put at least a temporary stop on any M&A activity that wasn’t already in the works earlier in the year. As has been mentioned in the past few months, executives must focus in stabilizing their businesses during the COVID-19 pandemic instead of looking at potential opportunities. In addition, logistical challenges have made parties reluctant to pull the trigger on new deals.

Pandemic Effects on Asset Valuation

Another challenge for potential acquiring companies is assessing the risks created by the pandemic and applying them to any potential deal, including integration challenges, and the true valuation of the asset. It’s a new set of risks to consider.

However, financing markets that were idle have begun to move with the middle market returning to what some see as “near pre-COVID levels,” which were then-record leverage levels. Further up the corporate ladder, the markets are even closer to their pre-COVID levels, which could soon provide financing to address stymied M&A demand.

Pricing has returned to nearly where it was before the pandemic. As a result, some groups are coming in 50 to 100 basis points higher than where they might have been earlier this spring. However, Asta told The Washington Business Journalthat “if you think about that compared to where these groups were two months ago at half the leverage they would have issued pre-COVID and they were charging 350 basis points higher, certainly lots of improvement.”

Companies considering corporate divestiture, such as Raytheon, Northrop and L3Harris, could soon be testing the waters with their noncore segments in the buyer’s market, with the thought that M&A activity could restart in the second half of the year, despite questions about the political and financial environment.

Takeaway

“I think the second half of this year will be as strong as any half of any year. You’ve got a number of reasons for that,” Asta said in the interview. “There’s a good seller’s market where you’ve got the backdrop of an election, the potential for changes to the tax rates depending on which administration gets through. So you’ve got a lot of business owners thinking, ‘If I’ve got an asset, do I want to go through an election cycle and a couple more continuing resolutions to see how the budget shakes out or do I want to just press forward now?’”