Leisure sector M&A awaits delayed reaction

COVID-19 is hammering leisure sector M&A—but not so much that opportunities have vanished

Leisure M&A deal value totaled US$13.5 billion in Q1 2020, which, although higher than figures recorded for Q1 2019, was more than 50% below Q4 2019 levels. Deal volume dropped to 117 transactions, the lowest quarterly total since Q1 2013.

Leisure and hospitality companies have been among the hardest hit by COVID-19 lockdowns. Had it not been for deals such as InterContinental Hotel’s US$300 million acquisition of Six Senses Hotels and Takeaway.com’s £6.2 billion (€7.5 billion) merger with listed UK counterpart Just Eat before the spread of COVID-19 accelerated, Q1 figures would have been even weaker. Deal figures are expected to drop further in Q2 amidst uncertainty around how and when lockdowns will be lifted, and how consumers will behave as economies reopen.

The Dow Jones Travel and leisure index has dropped by as much as one-third this year. Fitch Ratings is forecasting a 60% fall in European hotel occupancy in 2020 and, in the US, occupancy rates for hotels that remain open are in the high single digits to low teens.

Restaurants and gyms have been adversely impacted too. In the US, Gold’s Gym has been pushed into Chapter 11 and, in the UK, trade body UKActive estimates that up to 2,800 gyms face closure. Restaurant chains Carluccio’s, TooJay’s and FoodFirst have all gone into bankruptcy/administration. To stave off potential further damage, many leisure and hospitality businesses have drawn down as much liquidity as possible and as quickly as possible from their revolving credit facilities.

Given that restaurants and bars are still closed in many countries, travel restrictions remain in place, and the industry is still contending with material declines in demand and revenues, M&A in the sector will be challenging.

Pockets of opportunity

Despite the substantial headwinds facing leisure & hospitality operators, there have been pockets of resilience within the sector that have continued to support deal-making.

Quick service and takeout restaurants have continued to trade, and McKinsey reports that in the US, a number of chains have been hiring extra staff to cope with spikes in orders. With demand for takeout food holding up and expected to rebound to pre-COVID levels relatively quickly, investors have been on the lookout for deal opportunities.

Uber, meanwhile, has also seen opportunity to consolidate the food delivery industry and has made an offer for Grubhub that values the food delivery group at US$6.9 billion and would give Uber Eats a 55% share of the US takeout delivery market. Analysts see opportunity for further consolidation, with a tie-up between DoorDash and Postmates a possibility. Although the digital takeout delivery industry has grown revenues rapidly, many operators have still not turned a profit.

Other recent deals have also shown that dealmakers with cash are willing to navigate the current downturn and back companies that support long-term strategic objectives.

Canadian coffee chain Tim Hortons, for example, has secured an investment from Chinese tech giant Tencent in the coffee chain’s China business. Tim Hortons China is a joint venture between Tim Hortons owner Restaurant Brands International and private equity firm Cartesian Capital. 

Tencent sees strong growth in coffee consumption in China and the rising uptake of apps and digital services for ordering food and drink. For Tim Hortons, which opened its first store in China in 2019, the deal helps to accelerate store opening plans and boost its digital infrastructure.

Other leisure businesses may also look more closely at overseas deals, as lockdowns will lift earlier in some jurisdictions than others. Marriott, for example, has reported an increase in hotel occupancy in China, where restrictions are being gradually lifted. Other companies in the leisure sector may see M&A as a way to diversify their geographic risk to COVID-19.

Distress delay

A rise in distressed M&A deal activity in the industry is also a possibility, but for now, capital markets and incumbent lenders have shown willingness to support borrowers with repayment holidays and covenant waivers. Casino operator Wynn Resorts, for example, was able to amend its existing credit agreement and adjust covenant terms and reporting requirements.

Lenders have been reluctant to pursue enforcement strategies because exercising remedies may not offer the best path forward. Finding a buyer on the other side of enforcement action is unpredictable, and lenders are unwilling to pursue restructuring if it means they have to operate assets in such a difficult market.

In addition to support from incumbent debt holders, leisure and hospitality companies have found the market open for new borrowing. Cruise line operator Carnival, dining group Restaurant Brands International and hotel chains Hyatt, Marriott and Hilton have all managed to raise money in the bond markets following lockdowns.

As long as loan markets remain supportive, leisure businesses should be able to stave off distressed M&A.

Exercising caution

The uncertainty in business conditions that is prompting lenders to offer breathing room to borrowers in the hospitality sector is also putting the brakes on vanilla M&A. Dealmakers have no visibility into what they are buying, the pace of recovery or even whether the sector can bounce back to pre-COVID levels.

The only transactions likely to close against the current backdrop will involve deeply distressed companies that need a lifeline, obvious synergies between target and buyer or a very brave investor willing to pay yesterday’s prices. Deals that were pending, such as Allegro Merger’s bid to buy restaurant chain TGI Friday’s from private equity backers TriArtisan Capital Advisors and Sentinel Capital Partners for US$380 million, have been canceled in the face of uncertainty about the timing of a recovery.

Although deal activity has been put on hold, businesses will be eager to pursue M&A when economies reopen. The coronavirus has highlighted the importance of scale, geographical reach and technology. Companies with enough cash and lender support to withstand this downturn will be ready to invest in deals that equip their organizations with these strategic capabilities in a post-COVID world.

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