Sizing the Wave: Valuations Become Tricky, but M&As Will Find a Way Amid COVID-19

By Michael Collins

When the wave that lands as a tsunami first passes a ship at sea, it might move that ship up and down as little as two feet. Similarly, it is too soon to know the eventual impacts of COVID on company performances and, therefore, business valuations and mergers and acquisitions (M&A) activity.

As with so many other aspects of business, M&A activity isn’t immune to the “wave” caused by COVID-19. As those effects set in, door and window manufacturers have taken a triaged approach to the situation. In the first phase, they were solely focused on keeping their workers and their customers safe in a situation that was full of unknowns. All nonessential activity—including M&A activity—was temporarily discontinued. In the second phase, manufacturers focused intensely on safeguarding their existing operations by controlling expenses and meeting customer needs.

We are only now entering the third phase: attempting to return to the growth trajectory on which companies found themselves up until February and the first few weeks of March. This phase will continue throughout 2020 and into next year, in many cases including a return to M&A activity. It is in this third and final phase that the lasting effects of COVID will become clearer.

Acknowledging that the long-term impacts of COVID are yet to be known, many door and window manufacturers and building products distributors with whom we have talked in the past two months indicate that they believe the worst of the COVID effects may already be behind them. Thus, companies have begun to express their current and evolving acquisition appetites. Having buyers raise their hands and express their acquisition desires is a critical step to the restoration of M&A activity. In the meantime, most buyers are being reactive and opportunistic as it pertains to new acquisitions. They are asking to be made aware of any sell-side opportunities that exist, without necessarily committing to an active daily effort to find companies to acquire.

Acquisition criteria have three common elements: products, geography and size. But the final piece of the puzzle needed for M&A activity to return to normal levels in the door and window industry includes a methodology for approaching the valuation of companies whose earnings have been impacted. Sellers don’t want to sell at a discount because their previous trajectory of earnings were affected by COVID. Buyers are concerned about overpaying for a business if the lower level of earnings before interest, taxes, depreciation and amortization (EBITDA) that exists after COVID becomes the new level of earnings going forward. This difference in points of view exists in every deal, but it comes into particularly strong focus in an environment when many companies have been affected by a sudden and unprecedented external factor.

All companies have been affected by COVID to different extents and at different times. That being said, the solution will need to be one that normalizes the earnings of the company by comparing the COVID-affected period with the same period from last year. At the same time, comparing the monthly backlog and customer order levels with those of last year will help demonstrate that a company has returned to a more normal level of activity and is back on a growth path to deliver earnings similar to those in the past. In the meantime, one thing is for certain: like most things, buyers and sellers will find a way to continue these processes through the challenges of COVID-19. Through collaboration, deals will continue.

Michael Collins is an investment banker and a partner in Building Industry Advisors. He specializes in mergers and acquisitions in the door and window industry.

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DWM Magazine

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