7 January 2022

M&A: What Was 2021 Like and What Is Ahead in 2022

Despite the pandemic (or perhaps because of it), 2021 proved to be a strong year, at least in the M&A segment. There was healthy sentiment on the M&A market, with a similar number of transactions as in the pre-pandemic period. During the year, we could also see some large transactions or emerging trends on our domestic market. What was 2021 like from the perspective of our Financial Advisory team's management? What is ahead in the coming year and how will the increasingly mentioned ESG affect the M&A market?

Article Image - Review of 2021

These questions will be answered by partners from the Financial Advisory Department of our Czech and Slovak offices. Joining the interview were Partner in Charge Mirek Linhart (M. L.), CE FA Business Leader Ivana Lorencovicova (I. L.), Corporate Finance Partner Jan Brabec (J. B.), Transaction Services Partner Dušan Ševc (D. Š.), and Valuation and Modelling Director Roman Lux (R. L.).

1. How would you assess the M&A activity on the Czech market during 2021 in general?  And what do you think were the most interesting domestic M&A transactions this year? 

M.L.: The Czech M&A market has recovered from a pandemic decline this year. In contrast to 2020, when M&A activity declined significantly year-on-year, the number of transactions in 2021 was comparable to the pre-pandemic period. At the same time, this year we have seen a large interest of Czech companies to expand abroad. Even compared to the pre-pandemic years of 2018 and 2019, we worked on a higher number of outbound projects, where Czech companies carry out M&A transactions abroad. For me, the most interesting transaction of the year was the merger of Moneta Money Bank with the banking section of PPF, which includes Air Bank, Czech and Slovak Home Credit and Zonky. This transaction perfectly illustrates the need to consolidate the local FSI sector.  As we predicted a couple of years ago, the Czech banking and insurance sector must undergo consolidation, driven by falling margins and pressure on efficiency in the sector, as well as the ongoing digitalisation of banking, which requires very large investments that small banks often cannot afford.

J. B.: As for M&A activity this year, I agree with Mirek. The market has been as active this year as it was before the coronavirus pandemic. Transactions were smaller on average than a few years earlier, but there were many of them. Often these were medium-sized transactions in companies that have huge growth potential. For me, the most interesting transaction was the acquisition of the e-shop Ovečkárna. Ovečkárna is a company that combines the tradition of wool products with e-commerce innovation. The company was established by Martin Bernátek and an ideal partnership was formed thanks to the merger with Hartenberg Holding. Hartenberg can bring its many years of experience in building companies to Ovečkárna. A number of other very interesting transactions have also taken place on the market. Of course, we do not know the exact details of those we have not worked on. However, from my perspective, one of the key transactions this year was the merger of Avast antivirus with NortonLifeLock, a leader in protection against identity theft.

2. How has the ongoing pandemic of COVID-19 affected the number and volume of transactions? To what extent did you see a decline in transaction activity in the first two quarters of 2021 when the pandemic was culminating in the Czech Republic?

D. Š.: In my view, 2021 was a very active year in terms of transactions, with the pandemic of COVID-19 not having a negative impact on the size or quantity of Czech M&A transactions in the first two quarters. Conversely, the first half of the year was very busy on the M&A market, and there was also an interesting mix of large and small transactions. The high M&A activity could be caused by the fact that there is still a lot of money on the market at the moment and these funds had to be invested somehow. At the same time, investors seem to have adapted more to the coronavirus pandemic and it is not as unknown to them as it was in 2020. They are also able to treat the risks associated with COVID-19 in valuations, strategy and transactions. Last but not least, companies understand that creating value during the COVID pandemic is not just about controlling or reducing costs, but also about investing in growth activities, including new technologies.

M. L.: I agree. While many investors waited until October 2020 and there were very few M&A transactions, from November 2020 the situation turned around and we were swamped. Many deferred transactions were being completed and new ones were starting. However, in international comparison, the M&A market in the Czech Republic and Slovakia did not perform as well as in other European countries. For example, the neighbouring Poland or even more distant Romania performed better and M&A activity was even higher there this year than in the years before the pandemic of COVID-19. I attribute this difference partly to the fact that the Czech M&A market is more mature and saturated than Romanian or Polish markets. While we have an established tradition of buying private companies, the M&A market in Poland and Romania is still maturing, and at the same time, the Czech economy is recovering relatively slowly in international comparison. The M&A market goes hand in hand with economic development, especially with the GDP growth. When the Czech economy is not doing so well, investors are cautious and look for opportunities to invest in other countries that are doing better economically.

3. Considering that we are in the second year of the pandemic, do you think that it has affected the M&A process itself in the short or long term? For example, have you seen a longer average negotiation time or a longer period of waiting for results compared to previous years?

J. B.: COVID-19 slowed everything down a bit. While I have mentioned that there were as many transactions in 2021 as in previous years, that doesn't mean that those individual transactions were equally fast. It's undoubtedly clear that at certain times of the year people were unable to meet and some things really cannot be resolved online. For example, a management presentation combined with a tour of the company's operations is much better in person.

M. L.: That's right. When presenting a company online, it's difficult to ignite a passion for the company, an emotion or enthusiasm in the buying party. However, sometimes there is no other way to do it than online and I think that the trend of online communication with clients will continue in the following months and years. The big challenge for us in the future therefore remains to adapt and improve our online processes, including client presentations, to make them more user-friendly and interesting. We are already taking clear steps towards digitalisation, the first phase is our promotion at the upcoming M&A Deloitte Port, but in a few years, it may also be the sale of companies purely online.

4. Let’s talk about the impact of COVID-19 a little bit more. During the coronavirus pandemic, many companies used up their financial reserves and ran into liquidity problems. As a result of this trend, has the interest of owners to sell their companies also increased? Has the number of sell-side mandates increased?

J. B.: It certainly depends on the industry, there is no single answer for the entire market. Yes, there are sectors that have suffered significantly financially as a result of the coronavirus pandemic. These include in particular the hospitality industry, hotels, travel agencies and airlines. A number of companies, including some airlines in the CEE region, are currently undergoing restructuring. Then there are industries that already had problems before and the pandemic has made these problems worse. An example is the automotive industry, where we had already seen a slight decline before the pandemic, and the development related to the pandemic of COVID-19 has aggravated the difficult situation.   The industry has been affected this year mainly by chip shortages, shortages of production parts and broken production chains associated with the coronavirus pandemic. We are also seeing increased restructuring activity in many companies with links to the automotive industry. Of course, the pandemic has its winners, those being companies in e-commerce (Rohlik.cz, etc.) and IT. Companies in these industries were growing strongly during the lockdown period and this growth is unlikely to stop given the changes in customer behavior caused by the coronavirus.

5. Have you seen an increase in the popularity of carve-outs or spin-off transactions during the pandemic? If so, to what do you attribute this increase and do you expect their popularity to continue in the coming year? 

D. Š.: Yes, we have seen that indeed. The most common reason for these transactions is strategic thinking. As in previous economic crises, many companies are narrowing the scope of their business and focusing more on their specialised market segment during the current coronavirus recession. Telecommunications firms, for example, are strategically focusing on the customer, the quality of their services, and allocating infrastructure for investors to enter this area. This is also due to the increased efficiency of the telecommunications infrastructure, e.g. consolidation or energy savings, and of course the very interesting monetisation of the investment without losing control over it. An example is Vodafone, which has recently carried out a carve-out (launched a Europe-wide IPO) of its Vantage Towers, or CETIN in the Czech Republic and CEE region.

6. According to the CMS European M&A study, the 2008-2009 economic crisis in Europe resulted in an increase in the popularity of earn-out agreements, which define the purchase price variably based on pre-agreed economic (or even non-economic) targets. As the pandemic of COVID-19 caused similarly enormous economic uncertainty in the financial markets, did you see an increased popularity of earn-outs during the pandemic as well? 

D. Š.:  Yes, I can confirm the increase in popularity here as well. I would even say that the earn-out element or other form of delayed payment of the purchase price was negotiated by the buyers in almost every transaction we had in the last 18 months. Earn-out provides the buyer and seller with an opportunity to bridge the gap in expectations regarding the purchase price. The seller is willing to wait for a delayed payment of the purchase price because they believe in the future of their company, and conversely, the buyer is able to look at the expected economic return on their investment in this way.

7. How did the uncertainty in the financial markets affect the way transactions were financed? To what extent has the willingness of banks to lend to investors for M&A transactions decreased?

J. B.: From my point of view, the financing of acquisitions has definitely changed compared to previous years. In particular, banks have been more cautious about transactions in 2021 than they were a few years earlier. We are seeing a stricter assessment of acquisition financing and a requirement for a higher capital contribution from the buyer.

R. L.: We have also seen greater caution in valuations this year. Investors wanted to have the potential impact of a pandemic situation integrated into valuations, often seeking alternative views on valuations and requiring additional sensitivity analyses. Banks have also been more cautious this year and, particularly for larger transactions, have more frequently requested, for example, independent verification of models.

8. In 2021, what was the ratio of financial investors - i.e. investors who focus on buying companies to profit from their subsequent sale - to strategic investors looking for potential synergies and opportunities to integrate the company being bought?

J. B.: In 2021, financial and strategic investors had funds ready for acquisitions, which is also an important difference between the current coronavirus recession and the financial crisis of 2008-2009. Today, many large companies that have invested in CapEx (fixed capital) and technology over the last decade, and were not directly affected by the coronavirus, have a really comfortable liquidity.

Overall, I do not think that the ratio of financial and strategic investors has changed, but it is true that large Czech investment groups such as PPF, Penta and EPH have been very active this year, and the question is when these groups are financial and when they are strategic investors. However, I do not think that there is any big change where financial investors or strategic investors are predominating.

9. ESG (i.e. environmental, social and corporate governance) is becoming a big topic among investors. How do ESG issues affect the M&A transaction process itself? 

I. L.:  The ESG topic is one of the key issues in M&A and often a trigger for an M&A transaction. Companies are forced by regulations and customer demands to transform their businesses and invest in sustainable technologies. There is a growing interest in sustainable products among end customers and consumers are willing to pay more for sustainability. We are seeing this preference especially in the younger generation. Similarly, corporate customers are encouraged by their shareholders to buy products that meet certain sustainability criteria.

In terms of regulation, the European Non-Financial Reporting Directive already requires PIEs to report on non-financial indicators. More specifically, companies with 500 or more employees and a turnover of more than EUR 40 million or assets exceeding EUR 20 million are required to disclose their non-financial ESG indicators. In addition, the Corporate Sustainability Reporting Directive will come into force in 2022, covering all companies (not only PIEs) and reducing the number of employees criterion to 250 or more. Non-financial reporting will therefore apply to all large companies. These companies will be obliged to report ESG indicators already for the 2023 fiscal year, i.e. they will be required to issue an ESG report in 2024 together with the annual report.

Because of European regulations and changing customer preferences, ESG is becoming an increasingly important topic for investors considering potential acquisition targets. When an investor looks at a target, they want to know what the target company's ESG metrics are. They want to know if the company is ready, or has a plan to transform itself, and how much it will cost in the future. At the same time, ESG is also important from a transaction financing perspective. The new EU SFDR regulation (Sustainable Finance Disclosure Regulation) requires financial institutions to have special ESG reporting and European banks are forced to increase the portion of sustainable investments in their portfolios.

10. Are ESG issues also becoming more prominent in the Czech and Slovak energy sector? What other possible trends do you see in this sector?

I. L.: Yes, absolutely. In the energy sector, sustainability and green energy are becoming an important issue. More environmentally friendly energy production processes are being introduced, with the aim of reducing the amount of emissions released into the atmosphere during energy production. At the same time, the materials used in production are changing. This means switching from coal and natural gas to biomass or solar and wind power generation. In other words, energy production from burning hydrocarbons is being phased out and is being replaced by production from renewable sources.

This transition is partly funded by government and European Union initiatives, such as the Recovery Programme. Nevertheless, the introduction of sustainable technologies is still very expensive for most companies.

Until recently, many companies have rejected the introduction of sustainable technologies, arguing whether global warming is really caused by human activity or whether it is caused by the natural evolution of the planet. Scientists are clear on this point, and the pandemic of COVID-19 has also revealed a lot. We have seen that when production was reduced and flying stopped for a year and a half, the air in large (mainly Chinese) cities became significantly cleaner. It brought hope that if we change our behaviour, it can really have a positive effect. It's not about a few companies making drastic changes, but rather about each of us contributing a little. That way we will achieve the most positive impact.

11. During the pandemic, the digital transformation and e-commerce boom in the Czech Republic accelerated rapidly. Has the amount of mergers and acquisitions in this sector also increased during this period?

J. B.: Definitely. At Deloitte, we have seen increased M&A activity in e-commerce and the IT sector this year.  The big advantage of these sectors is that they are not so dependent on (this year's disrupted) production chains, and they can also quickly become global, not just local or regional. In recent years, a number of Czech e-commerce and IT companies have started to outgrow not only the Czech Republic but also the Central European region and have decided to expand more globally. Some of them looked for acquisition targets not only in the CEE region but also in Western Europe, Asia or the USA. Conversely, traditional firms in the affected sectors, such as hospitality and tourism, consolidated. At Deloitte Financial Advisory, we have been involved in a number of interesting projects this year, not only in M&A, but also in the restructuring of several Czech companies. Last but not least, we supported a number of companies in the preparation of business plans and subsequent negotiations with banks for (re)financing. Here I also agree with Ivana that the ESG and EU taxonomy starts to dominate the market, and especially large companies with billions of debt. Banks and investors on the capital markets will increasingly demand that borrowers/issuers are proactive in ESG and Green Deal compliance.

12. Speaking of digitalisation and communication, what do you think were the main trends and most interesting M&A transactions in the telecommunications and media sector?

D. Š.: In the telecommunications sector, the monetisation of infrastructures is a clear trend. Both Vodafone and the PPF Group have used 2021 to monetise part of their infrastructure investments and sell a partial share. For example, PPF Group sold a 30% share in CETIN, a Central European operator of fibre-optic networks and telecommunications towers, to the Singapore investment fund GIC. I think this trend will continue in our region.

13. The pandemic of COVID-19 has also disrupted existing logistics structures and, as a result, increased the cost of materials and real estate. Has the pandemic had any impact on M&A activity in the real estate sector as such?

M. L.: Each segment of the real estate sector underwent a slightly different development in 2021. In the commercial real estate segment (Retail), many projects have been put on hold and uncertainty prevails. Future development will depend on the extent to which people return to shopping in person in shopping malls and the extent to which retailers themselves move their business online. There is also uncertainty in the office real estate segment (Office). Of course, the pandemic has rapidly changed the way we work, we are seeing lower occupancy and stagnating office rents. Some developers are therefore already putting projects on hold. On the other hand, apartment prices are rising or at least remain at the same level. This is because housing prices are a function of income and incomes have been rising despite the pandemic in 2021. The rental housing segment is also strengthening and will continue to do so, which is a new field for institutional investors. However, warehouse real estate was the clear winner this year. Currently, occupancy and demand are higher than at any time in history. This growth is partly limited by the labour shortage in the sector, which may change in the medium term.

14. To conclude, what is your overall outlook and forecast for the M&A market in 2022? What trends will dominate in 2022?

I. L.: On the M&A market in CEE, the consolidation will continue, especially in the energy, banking, insurance and retail sectors. This is partly because customers have actually changed their behaviour during the pandemic and have become accustomed to shopping or even taking care of their finances and insurance online. We have also seen similar development in the United States, where entire retail chains, such as the multi-million- JCPenney chain, have gone bankrupt, while the e-commerce sector is experiencing a major boom. The consolidation is also driven by the fact that the technology to develop these online stores, or to develop online banking and insurance, costs a lot of money and the small players do not have the resources to do it. At the same time, I predict that in 2022 some office premises (especially the low-quality ones) will be transformed into residential housing.

M. L.: I agree. For old and obsolete office buildings, I also expect that there will be a transformation to housing in the future. This is also ESG-related - older buildings are not worth renovating and converting to office space that meets current ESG standards. I think these offices will be converted primarily to rental housing where no change in urban planning is needed. At the same time, office space will be optimised, but not in a dramatic way I think. Even though remote work has become and will continue to be an integral part of office work, businesses will get bigger as part of the projected future economic growth. Due to these conflicting factors, office space may not grow as fast as it did before the pandemic, and may even stagnate for a while, but I do not think it will decline in the long term. It is also due to the fact that people need social contact in their daily lives, they need to meet in offices. After all, even in Maslow's pyramid, social contact is right at the bottom, it ranks among the most basic human needs. We humans need to shake hands, hug each other, and that cannot be done online. That is why I predict that the combination of working from home and working from the office will become more prevalent among employees.

J. B.: I will follow up on what Ivana mentioned. I also think that the e-commerce sector will continue to boom on the market and I predict a similar boom for companies focusing on blockchain technology. I expect that the e-commerce sector will continue to consolidate, and it may not just be buying and selling companies in this sector, but also listing them on the stock exchange. Overall, I anticipate more activity in initial public offerings (IPOs) in the coming year. I believe that medium-sized Czech companies as well as international ones will be active on the stock exchanges in Prague, or even in Amsterdam or London. In exceptional cases, we may also see listings in New York[NM1] .  On a larger scale for 2022, I expect a similarly high level of Czech M&A activity as this year, with a high number of buy and sell mandates.

R. L.: I also believe that the sentiment on the M&A market will continue in the coming year. One example is the development of the banking market, which has recently experienced an unprecedented recovery in the Czech Republic. This year alone, there have been three transactions, i.e. the sale of ING's retail portfolio, Equa Bank, and the aforementioned merger of Air Bank with Moneta, which was completed before the end of the year. In general, the acquisition and consolidation trend should not stop in the coming year, although the number of acquisition targets is limited and the higher cost of money following the repeated interest rate increases by the central bank may have negative effects. However, despite the ongoing problems within logistics chains and the continuing pandemic in the economy in general, optimistic expectations still prevail, boosting the buying appetite. We are also increasingly seeing local players looking around the greater European region.

D. Š.: As Roman mentioned, it will be interesting to see the effects of high inflation and related rising interest rates on the M&A market in 2022. We have already seen an increase in inflation pressures in the final months of 2021 and, among other things, a consequent rise in the cost of bank financing for M&A transactions. Of course, rising interest rates also have an impact on valuations in M&A. I expect rising interest rates to continue in 2022 and I am therefore somewhat cautious in my forecasts. On the other hand, the volume of available funds on the market is still large. For example, several private equity funds in the CEE region, including the Czech Republic, have gained significant amounts of money in the last 18 months for future investments. So all in all, I hope that in terms of M&A, the year ahead of us will be at least as interesting as 2021.