How are Business Owners and Investors Preparing for a Potential Recession?

Nov 2019

Lincoln Managing Directors share unique insights about how Technology, Media & Telecom, Business Services and Healthcare business owners and investors are preparing for a potential recession.

 

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Summary

  • Lincoln International shares insights on Technology, Media & Telecom, Business Services and Healthcare business owners and investors preparation for a potential recession.

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How are business owners and investors preparing for a potential recession?

Will: I mean I think technology, which is where I focus my time, is every company is going to be in some way negatively impacted by recession, but I feel positively, on a relative basis, about how technology will fare. One, any useful technology either increases operating or financial efficiency almost by definition or it’s not being used, so if you’re using those tools, you’re going to probably become even more reliant on those tools in a recession, which should be helpful. Secondly, you look across all industries outside of tech, whether it’s automotive, healthcare, you name it, finance, all those industries are relying upon technology to stay relevant, and it’s hard to believe that’s going to change in the course of a recession. In fact, I think the opposite is probably the case. Also, I think the business model of the majority of the companies we work with is a subscription, multi-year contractual revenue model. As that business model increasingly takes over the software sector, those companies should be less subject to a downturn. They should be more resilient based on that business model than companies that require huge capital expenditures. So, I think all those things mean that although no doubt technology will be affected, it’s going to be less impacted. The last thing I’ll say is, it’s hard, especially if you’re a non-technology company, to build all of the technologies you need to run your business on a day-to-day basis, and so it’s much more likely that you’re going to buy that rather than build it. Again, all those things lead me to be relatively optimistic to how tech will survive and maybe even thrive in a downturn.

Francois: I’ll stay on the topic of the economic landscape it was going to happen. I think it’s true that investors are really scrutinizing our companies’ growth profile, the competitive landscape, the quality of the management, and basically they want to know if they are investing at the top of the peak and what’s going to happen if there’s a downturn. As Rob you said, I think that in our processes, with our customers, we go quite deep to help them prepare for that. I was thinking for instance about this deal we just did with a unified comm company. I think one of the key selling points of that process was the fact that we demonstrated after a deep dive in KPIs to construct cohorts, this sort of reliability of growth and consistency in the past over hundreds of channels, and therefore, we could really demonstrate the projections going forward. Another thing is for us as bankers is to really take every project and think what’s the best structure for that project. And I think talking about growth, some of our clients are fortunate enough to be on a strong growth structure, sometimes hyper growth, and for instance we sold that mobile gaming company this summer. That company was growing the bottom line 10x a year. So here the challenge was “okay how do I structure my deal to obviously capture a large chunk of the value upfront?” but also trying to find an equilibrium between the parties to capture the future growth, and fundamentally make sure that the management would remain sufficiently motivated to stay on that trajectory.

Chris: Perhaps to give a little more of a European perspective on this. To pick up on Will’s point – resiliency. I think we are seeing a greater focus from trade and investment community in particular on resiliency of businesses. It doesn’t just mean recurring revenue, although recurring revenue is great of course, whether it is subscription revenues or contracted services, but it also means I think there’s just greater focus on market leadership, differentiation of a business, the track record of a management team. I think what that will mean is that perhaps there will be a greater divergence between the winners and losers. Inevitably if the economic conditions do change, I think it will throw up opportunities, and I think on the winning side, what that will mean is the businesses that do have those really positive attributes which manifest themselves in a good strong growth rate, I think that we’ll find that for those businesses, they will continue to attract premium valuations and a lot of interest from investors. I think there’s also room at the value end of the spectrum as well and maybe there will be some companies that need further assistance and support from investors that can properly help those companies through that. But perhaps, the challenge and where we see the greatest change is in the middle there where a lot of companies I think have the good companies but maybe not totally exceptional, which have ridden the wave of strong markets, and perhaps there will be a little bit more of a microscope on those businesses going forward and I think we’re already starting to see that in Europe.

Barry: Just building real quick on a point that Chris just made about winners and losers and bringing it back to a healthcare context is that, going back to the earlier point about cybersecurity – healthcare is really grappling with that right now because of the proliferation of wearables and the implementation of AI and ML to diagnose and consume mass amounts of claim data to try and predict people’s health status, but the technology is almost advancing more rapidly than the laws and the frameworks can keep up with it, and so, it is a huge issue. There’s some very high-profile, and even just last week Google got slapped with some bad press over its relationship with Ascension Health. 50 million patients’ personal healthcare information was consumed by Google without following the proper protocol. It’s a huge ongoing issue for healthcare but talking about a downturn. In healthcare I think it’s generally viewed that the industry does not follow the same cycle as maybe other sectors of the economy and that demand tends to be a bit more evergreen across the board. So, I think as people start to look at deals in the healthcare landscape, there’s maybe a little less concern than the traditional “what happened in the last recession, let’s compare” and it’s sort of confounded by the fact that there’s been this massive regulatory change really since the last downturn because the Affordable Care Act, also known as Obama Care, was passed in 2009, and so the framework that a lot of companies are operating in today is totally different than what it was at the time of the last downturn. We’re finding that investors are much more focused on understanding, what are the drivers of growth that have explained the last many years of performance and how sustainable are those, and what’s maybe the outlook on capitol hill, relative to any sort of regulatory changes or political changes with the upcoming election next November for the presidency and how might that impact a company’s standing in its industry or with its reimbursement dynamic. That tends to be much more of a factor than assessing recessionary demand changes.

Saurin: Yeah Barry, as you mentioned, the election cycle is a discussion topic coming up more and more in meetings that we’re having with prospective clients as they think about selling a business. I heard it last week put really well is that the only thing we know is that it’s going to get stranger from here a year from now. Regardless of which way you lean. So as we think about advising clients ahead of a potential marker pullback, whether that’s 12 months, 24 months or whatever the crystal ball says, I think analytical preparation is something that we are advocating for and spending a lot of time with data, whether it’s revenue or earnings or otherwise, and really trying to understand what’s recurring, what’s non-discretionary, where its coming from in terms of the customers capital spend, is it hitting the capex, is it hitting capital budget lines, and really having a good idea of how sustainable is that growth. So, if you do have a market pullback, how is that going to impact the business and having it really rooted in analytics, as opposed to a qualitative framework. The other area we are spending more time and it’s strange for a banker to advocate for this is actually a downside or recession-based scenario forecast model, not that you would ever lead with it, but to have in your back pocket so that as you get into more detailed discussions, your management team has spent time proactively thinking about if there is a 10% or 15% pullback in the market, how does it impact my individual end-markets, what are the cost levers that I have in the business that I can pull, especially a lot of professional services organizations tend to have a pretty high variable cost structure, and so we’re putting forth our analysis, as opposed to allowing buyers to determine their draconian scenario of what happens. It is especially helpful as you start to speak with lenders who are obviously a little more conservative in how they approach businesses. So, that is another area we are spending more time today than we probably did 12-24 months ago. I think the third area that we are advising clients or at least having discussions is for businesses that are more contractual in nature may have multi-year contracts and the expiration of those contracts might be still 12-24 months out, is there a strategy to go back to those customers and talk to those customers about a potential contract extension? Maybe you trade a little bit of the price in exchange for an extension or renewal on those contracts, so that if you do go to market and you are facing some headwinds in the general economy, you can point to 3, 4, 5 years of contracted revenue, and therefore, have a stronger case to make. So, these are all discussions that continue to be more and more active in many of the businesses that we advise.

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