Due diligence: Measuring ‘covid bump’ as tough as assessing distress

The permanent positive and negative effects of the coronavirus pandemic on businesses are equally difficult to analyse, according to panellists at PEI’s virtual Operating Partners Forum NY.

When it comes to conducting due diligence on a potential asset prior to acquisition, the effects of the coronavirus pandemic are making analysis a whole lot tougher – whether a business is benefiting or suffering from the changed environment.

“For us, distressed and ‘covid bump’ are equally hard,” said an executive at a global private equity firm, speaking on a panel at Private Equity International’s virtual Operating Partners Forum NY last week.

The executive said he is working on diligence for a company experiencing a big “covid bump” – a positive impact on performance driven by coronavirus-induced market changes.

“Management presented these projections with the hockey stick [projected growth chart], and guess what, the initial part of the hockey stick is the covid bump. So it’s a tough discussion,” the executive said.

One executive at a mid-market private equity firm talked of handling “both ends of the spectrum” – diligencing assets experiencing a “covid bump” and those in deep distress.

For the one that’s experiencing growth, the challenge is understanding “how much of that are you going to give back once you don’t have this bump from covid?” For the other, it’s making a judgment on when the bounce back is going to happen.

“You’re looking at it and saying, ‘ok, how much cash do I need to put on the balance sheet to see [the company] through to the other side of this, because I’m pretty sure that once you get to the other side of this desert, you’re going to be fine, but I need to make sure you have enough water in your glass to survive from one side of the desert to the other.’”

Part of the due diligence on those assets includes talking to customers and looking at “every lead indicator we can lay our hands on to try and figure out when we think the market recovery will come”.

“I don’t think there’s much of an alternative but to think about putting a bit more equity into it than you otherwise would have on the assumption that maybe you could adjust your capital structure later on.”

The first executive from the global firm said his team has “doubled down” on analytics capabilities.

“Being able to distil the covid bump is all about analytics,” the executive said, adding that in a market that’s “still hot”, it’s important to “stick to your guns” and pass on assets that do not seem to be appropriately priced.

“I think the key is to assess, is there a fundamental change in consumer behaviour? And then, is that temporary or is it permanent?” an executive at a lower mid-market specialist added.

“Everyone knows that certain consumer products are doing well because of the stay-at-home environment right now, but that’ll start to erode,” the person said.

“A question in my mind is, does it just go back to the normal activity? Or [was it that] all it did was advance purchases that these consumers would have made anyway? Therefore, it actually will decrease below the normal level. These are the types of analysis you have to look at, and we spend a lot of time trying to assess them.”