Global retail M&A volume drops to lowest total since 2009

COVID-19 has put dealmaking in the already disrupted retail industry under further strain. Some retailers, however, have proven resilient and those that survive will see opportunity to vertically integrate supply chains and invest in technology capabilities

Retail deal value may have climbed in Q1 2020, but the sector suffered its weakest quarter for deal volume for more than a decade.

Total deal value of US$18.3 billion in Q1 2020 was 5% above the previous quarter and 13% above Q1 2019. But more than half of the Q1 2020 quarterly figure derived from UK supermarket chain Tesco’s sale of its Malaysian and Thai businesses to Thai conglomerate Charoen Pokphand for US$10.6 billion. The deal, the largest in Thai history, was announced on March 9, 2020 and signed just before the COVID-19 lockdowns, and approved by shareholders on May 14 (the deal remains subject to customary regulatory approvals).

Retail M&A volume served as a better barometer for retail sentiment, dropping to the lowest quarterly total since Q3 2009, with only 123 transactions struck in Q1 2020. The coronavirus would have been one contributor to the drop in activity levels, but even before the outbreak, the retail industry was in a state of flux. Before shutdown, brick-and-mortar retailers of non-essential products in much of the world were already facing headwinds, with online shopping, high business rates, discounting and rising labor costs all combining to disrupt business models and erode the earnings of traditional players.

The full extent of the coronavirus’s impact on retailers is still to emerge, but lockdown has pushed a number companies that were under pressure prior to the pandemic over the edge. In the US, JCPenny, Neiman Marcus and J.Crew have all filed for bankruptcy, while on the other side of the Atlantic, Arcadia and Debenhams are among the high-profile names to undertake restructuring or file for administration.

Deal delays

The distress in the sector, and uncertainty around when lockdowns will be lifted, has put deals involving performing retailers on hold. Sycamore Partners, for example, has terminated a US$525 million deal to acquire a 55% stake in Victoria’s Secret from L Brands.

Obligations to honor long-term leases when unable to trade remain a significant barrier for potential buyers to overcome. Landlords are typically well-protected in lease agreements, and in the US even when agreements include force majeure clauses (which offer relief to leaseholders in exceptional circumstances), there are provisions that still require monetary obligations pursuant to leases to be honored. With little visibility on when or how lockdowns will be lifted in many jurisdictions, buyers are reluctant to close deals and take on these costs.

Bright spots

For all the disruption to the sector, there have been some bright spots. Food and online retailers have performed well and earnings have proven relatively resilient. The UK’s ten largest supermarkets, for example, all reported strong sales growth in Q1.

The steady performance of food and online retailers has not come without challenges. Labor, the implementation of social distancing in warehouses and stores and investment in protective equipment have added to costs. Retailers with food and non-food lines have seen good sales but smaller margins, as shoppers hold off from making non-essential purchases.

Food retailers have also experienced a substantial rise in online demand, necessitating large outlays in distribution centers, logistics and technology infrastructure. In the US, supply concerns have arisen, with the availability of products like meat, which require intensive labor, tightening.

Tyson Foods, for example, shut down one of the largest beef processing plants in the US after 900 staff tested positive for the coronavirus, while fast food chain Wendy’s has stopped serving beef in some of its restaurants because of the shortages. Supply bottlenecks have been less acute in Europe, but retailers with vertically integrated production and distribution supply chains have benefitted.

Deal opportunities are likely to emerge as retailers respond to the lessons learned from COVID-19. M&A will be on the cards for retailers who want to vertically integrate their supply chains, and deals that increase technology and distribution capacity will most certainly escalate. US retailer Target has entered talks to buy technology assets from same-day delivery start-up Deliv (which is to wind down), and in the UK, Amazon has made an investment in food delivery group Deliveroo.

The distressed circumstances that have expedited such deals also highlight the likelihood of more distressed deals in the retail space. High yield and leveraged loan markets have been effectively shut for all but the most resilient credits, and with limited options available for supporting balance sheets, distressed deals, debt-for-equity swaps and sale-and-leaseback transactions could rise.

Hedge funds, turnaround investors and distressed debt players may be less likely to pursue vanilla control deals. Oak Street Realty Capital, for example, has provided a US$725 million financing package to US discount retailer Big Lots through a sale-and-leaseback of the company’s distribution centers.

Mainstream private equity players, however, will not sit on the sidelines. Canadian investment manager Brookfield, for example, has announced a US$5 billion program to fund retailers with revenues of US$250 million or more that have been adversely affected by the coronavirus. Ron Bloom, who headed the Obama administration’s bailout of the automotive industry, will lead the initiative.

The COVID-19 crisis has accelerated the retail industry’s shift to online, and will prompt other long-term changes to the way retailers work with staff, manage supply chains and distribute to customers. As lockdowns lift and valuations stabilize, M&A will be an important tool for retailers as they adapt.

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