Corporate Insights Weathering a storm
(3rd Quarter 2020)
- We find that more liquid firms outperform during market dislocation events
- We therefore recommend our clients to manage cash balances "through the cycle," assuming that more disruptions will happen
- Firms must assess the likelihood and size of the adverse impact a cash shortage will have
- This challenges the thinking of what the value of a dollar should be
- We show that times of market dislocation can provide unique opportunities to play offense on M&A
- M&A transactions executed at the time of market dislocation can outperform other periods by ~10% within a year
- Even though premiums might be higher during a market dislocation, the overall purchase multiple might be lower
In just the last 20 years, we have seen multiple "once-in-a-lifetime" crises that have devastated economies, capital markets, businesses and personal lives. The nature of these events comes in all shapes and sizes: financial bubbles, global conflicts, natural disasters and viral pathogens are each shocks that habitually challenge the status quo.
A number of these respiratory virus outbreaks seemed to serve as a shot across the bow for what we collectively face this year. As the Covid-19 virus spread rapidly around the world, transforming into a deadly global pandemic, businesses shut, employees were laid off, economies went into free-fall and the equity markets fell. The outbreak of Covid-19 left market observers scrambling for ways to embed the term "Black Swan" into everyday dialog, desperate to make the point that the current outbreak was unprecedented and entirely unexpected; businesses could not be expected to anticipate a viral pandemic!
Perceived once-in-a-lifetime market dislocating shocks have proven to be less rare than people assume them to be. Although no one can predict exactly when a global market dislocation will occur, it is an inevitable occurrence that still tends to catch our society off guard each time. These periods of market dislocation have been referred to as "Black Swans", an archaic term recently popularized by Nassim Nicholas Taleb: they are something believed to be impossible, based on the early European experience that all swans had white feathers. The term has become a metaphor for a once-in-a-lifetime sighting. However, "rare" events come to pass more frequently and can prove disruptive at best and deadly at worst.
The point is – we may all have short memories and failures of imagination. But from the relatively recent historical incidences of respiratory outbreaks and viruses (The Spanish flu, Ebola, MERS, SARS, etc.), all the way to Hollywood films ("Outbreak", 1995; "Contagion", 2011), the warning signs existed. In addition to history and Hollywood, the World Economic Forum listed a fast-spreading pandemic as one of the main risk factors in 2019. Despite the highly-ranked risk factor, a recent report showed that less than a third of publicly listed corporates incorporated this risk in their annual reports. Bill Gates, in a TED Talk in 2015 said "... we have invested very little in a system to stop an epidemic. We’re not ready for the next epidemic."
But still, the coronavirus pandemic has not all been bad news – businesses have adapted and developed new, more efficient practices while working from home, new industries have emerged and decentralized decision-making has led to improved operational performance at times. This means that planning for the next "once in a lifetime crisis" or the next "once in a century flood" is not a waste of time, money and effort. Instead, such planning should become part of every company’s strategic and financial toolkit.
In this paper, the 16th in our ongoing series of Credit Suisse Corporate Insights, we look at some of the dominant themes that we’ve seen correlated with corporate success emerging from prior crises. We will challenge conventional thinking around cash management and question whether companies would be better off taking a long-term view on liquidity "through the cycle". Along with this defensive tactic to "weather a storm", we will also show that times of market dislocation can provide great opportunities to play offense, particularly when it comes to M&A. These two topics go hand-in-hand and should be viewed as holistic capital allocation planning. We hope to shed light as to when it is best not to follow the crowd, but rather to walk in the other direction through building a custom framework around your specific needs and vulnerability. Consistent with capital allocation and management themes we have touched on before, we believe there are lessons to be learned, and paths to be taken to ensure that – the next time – you and your business will be better prepared.