Dealing in Uncertain Times

Dealing in Uncertain Times

2020 was one of the most unprecedented years in living memory. In East Africa, restricted movement, curfews and border closures began towards the end of March 2020. As of this writing, borders have largely opened and movement is somewhat less restricted and yet life is still quite far from the norm in “2020 BC” (Before COVID-19).

From an economic perspective, many of the countries in the region were already bracing themselves for slower growth before the pandemic due to various factors. Tanzania and Uganda had elections scheduled, which in this region tend to be fairly disruptive to business. Kenya is scheduled for a general election until 2022, but the political discourse around the Building Bridges Initiative (BBI) was heating up. Then COVID-19 emerged.

Traditionally, deal activity in Kenya tends to follow the country’s election cycle. In the year of a general election, there would tend to be many fewer deals, with activity picking up in the years after the election until the campaign period for the next one begins anew. This has generally been the case since the violent and disruptive period following the 2007 elections in Kenya. The same cycle is very much evident in many of the country’s sectors that are key economic contributors such as tourism, services, manufacturing and agriculture.

COVID-19 has had a direct impact on deal flow worldwide. In some cases, the impact has been positive, as we saw early on with technology stocks that rallied with demand for video conferencing platforms to support working and learning from home, as well e-commerce that surged with many consumers preferring to shop online for pretty much everything. However, many also experienced a bear run characterised by a sharp decline in demand coupled with disruption of global supply chains.

Although the official numbers are not yet out, we have also seen much less deal activity in the last twelve months here, closer to home. Many deals that were in the pipeline for execution were delayed or put in abeyance until there was a clearer picture of what the impact was on industry and the economy overall. Deals that were in due diligence required more intricate review of monthly and in some cases even weekly performance to understand the evolution of the business as it weathered the pandemic. These reviews focused on revenues, costs, cashflows, the impact on supply chains as well as arrangements with lenders and funders of the business.

In many cases deals needed to be restructured, with a need for additional funding, or review of current funding arrangements such that they could align better with current business activity. Earn-outs became more commonplace in phasing the consideration payable on deal closure, with investors hedging on improved performance once the pandemic was managed or “over”.

In some cases, the earn-out periods were extended beyond the usual 12 to 18 months, allowing for a longer period until results were optimal, and also reflective of investors’ belief in the business case of the target under consideration.

With regards to strategic acquisitions, in many cases discussions have revolved around extended business partnerships before proceeding to transactions, allowing investors to have a better grasp of business operations (perhaps a form of extended due diligence) before proceeding to full acquisition. Although not always ideal, this may allow for interest in targets that are uncertain to continue with the hope of an eventual deal. The risk however will be that in the event of a deal not progressing, the partnership would have allowed the investor to mine information on the target that may be used in setting up their own greenfield operations and equipping them with competitor information.

Globally, the pandemic is quite unique in that funds and strategic investors have been flush with cash, particularly in comparison to the last global financial crisis. Valuations have remained high with too much money chasing very few deals. In the region, where this was the case even before the pandemic, the same scenario has continued to play out, even in cases where targets are in great need of investment. This has been part of the influence between the extended earn-outs and partnerships as discussed above.