Vito Sperduto:
Hello and welcome back to Strategic Alternatives, the RBC M&A podcast. I'm Vito Sperduto, Global Head of Mergers and Acquisitions at RBC Capital Markets. As always, I'm joined by Larry Grafstein, Deputy Chair of Global Investment Banking. Hi, Larry.
Larry Grafstein:
Hi Vito. Nice to be here, as always.
Vito Sperduto:
And today for our second episode, we're rejoined by John Kolz, Global Co-Head of Equity Capital Markets here at RBC. John, welcome back.
John Kolz:
Thank you, gentlemen. Great to be back.
Vito Sperduto:
So John, we talked in the last episode a fair bit about the conditions, especially over the past year and what we're seeing in the market currently. I think most importantly, our clients and our listeners would love to hear views in terms of what kind of market are we expecting as we go into 2024? What's available? What signs are you looking for in terms of the IPO window?
John Kolz:
It's a great question, Vito, and one that frankly we struggle with a little bit, because, on one hand, you'd have to conclude that the market is technically open, including the IPO market. The statistics of issuance being up almost threefold from last year support that. Some very big transactions having gotten done, three of the six biggest in the last five years. And the overall volumes in the equity capital markets being up almost 20% for the year.
On the other hand, it is nowhere near the historical volume levels that these markets can and should produce. And the transactions that have come, have been disappointing in many respects, mostly with regard to aftermarket performance and the type of returns that investors who participate in those IPOs received.
So there's no easy answer to are we open or not? Most, I think would say, most who are considering how much, what value can I get, are still saying, I'm not going yet. I'm going to get prepared. I'm going to continue to evaluate my alternatives, whether that's IPO, whether that's another private financing round, whether it's time to pursue the strategic markets, whether it's to take on a new partner for the investment. That has been the pervasive view from venture capitalists, from private equity, from managements themselves.
The question of is it early '24? Mid, late '24 or beyond? It seems like we've been talking about the broad reopening of the market being three months away for about 18 months now. I hope we're actually approaching the point where the '24 momentum will really take hold.
We will get into this surely, of the things that could throw us off the rails of which there are many, but there are a lot of issuers out there waiting. There are a lot of investors out there waiting. And we need to find the equilibrium. Supply/demand is something that we talk about quite a bit. I'm a believer in that. I think we have not quite found the equilibrium at this point, and hopefully that's in early '24.
Vito Sperduto:
John, sometimes we talk about clients accepting a quote/unquote, "new normal," because you'll go through a time period where there are spikes in valuations and you look at something like, especially when we went through 2021, we saw companies selling at incredibly high multiples. We saw companies accessing the markets at incredibly high multiples. And, in fact, when we've looked at, and especially as we look at the tech IPO market as a barometer, I believe that in '21, based on a study we were looking at that multiples for tech companies that went public in '21 generally were something like on average 15 times revenues, which the only other time it's been higher than that was in the 2000 dot.com peak, where it was over 30 times.
And where we've been this year, in sort of the mid-single digit multiples of revenues, it's pretty much in line with the period in between those.
So do you think that the folks that are looking to access the market have expectations that have not gotten to that new normal yet and are still looking at what happened in '21 and not reset appropriately and therefore maybe are expecting too much or waiting for too much?
John Kolz:
I think there's a little bit of both, Vito. I think there certainly are some. Like everything, there's likely a distribution of answers to that question.
Many, undoubtedly, think they're the one who has been unduly punished and deserves a higher valuation.
That said, I think, by and large, the new norm, if that's a thing, the new norm in valuation has settled in. That's partly because of the economic environment that we're in, partly because of the results in their own business, partly because of simply the one that's maybe simplest to understand. If you're a perpetual software company who are discounting your cash flows from a license over at a much higher interest rate, it's just worthless today. That economic reality, which has been written about quite extensively, is there.
The dynamic that's harder to put your finger on is many companies got through this desert of lack of issuance and lack of IPOs by restructuring their own businesses and turning the corner and becoming profitable.
So quite simply, they don't need the IPO as much as they used to. The IPO historically was a funding event. It not that much of a funding event anymore, in some sectors.
Biotech maybe is the glaring outlier to the contrary. Biotech has been a very robust issuance volume for this year and '22. And some of the big down years, biotech has kept the lights on, and that is still the case, that most biotech companies need the money to finish their clinical trials, to run their businesses.
Many of the tech companies who accounted for the vast majority of the high profile IPOs needed the money as well, and now they're profitable. We told them to go get profitable. They have.
So it raises the stakes a little bit for who has the leverage in the negotiation on price and whether you want to do something or you need to do something in the market.
Larry Grafstein:
So John, a lot of our listeners often focus in on the IPO market as well as just equity market trading levels, and that really is the highest profile aspect of equity capital markets.
But as our head of equity capital markets, talk to our listeners a little bit about some of the other aspects that are out there beyond IPOs. Convertible securities, private placements, so-called ATMs, equity margin loans, the use of derivatives and options and even block trades. RBC led one of the biggest block trades in many years in any market recently for Enbridge. Talk to us a little bit about those types of equity capital markets activities beyond the IPO market last year and next year.
John Kolz:
I continue to be pleasantly surprised and amazed in some regards that these markets continue to evolve and I think that is healthy, and I think that is something that is a hallmark of the creativity that sometimes that Wall Street as a whole does not get credit for.
Sometimes it, maybe often, it is overblown and goes too far, i.e., the SPAC market, we had some 150 billion of issuance where in reality we were selling dollars for 98 cents and obviously that is a market that went too far, too fast, but it was something that maybe in hindsight, the market needed at the time. It was a mechanism to bridge a gap at the time.
Today, with perhaps a little bit more rationality out there, markets that you mentioned, whether they're the convertible market, the convertible market is up dramatically this year and we expect it to be again next year, that is a perfect product to bridge a higher interest rate environment than you have seen as a corporate for a long time and a stock price that you're not quite happy enough with and you don't want to issue at today's price.
So sometimes converts in its simplest form are just that. They're lower cost debt with a promise that... The quid pro quo is I will sell my stock at a slightly higher price to pay for that lower interest rate. And that's exactly maybe what the market needs.
And one of the other dynamics we speak about quite often is the pent-up cash on the sidelines at private equity, but also the pent-up demand to monetize existing assets, equity margin loans, call option overwrites, many other derivative technologies that can help sellers of assets in the case of call option overrides, squeeze a little more value out of their shares or equity margin loan. I have this asset that is sitting on my books that I'd like to get some value from and take a loan against it and help provide some return to LPs. Those are fill in the gap for the lack of the more traditional products these days. Certainly private placements, certainly private credit in some regards has sort of emerged to fill some gaps that the traditional markets weren't doing. I think that is all healthy. We just got to try to avoid the mistakes of the past, of letting it dominate a market too much to unhealthy levels.
Vito Sperduto:
John, one point that we've discussed a fair bit is that one of the things that has happened in this environment, given that there hasn't been as much of a market window in both of our markets in some cases, is that private assets have been held for longer periods of time, even just slightly longer. I think the numbers are somewhere between three quarters to a year longer on average than they have been historically in portfolios, but they've gotten larger. And I think they've benefited from some growth that has produced some very large chunky assets. These are quality assets and certainly I think we're looking at those businesses and trying to figure out how they're going to lead as we think about the market, from a go forward perspective.
How are you thinking about those situations? Are there different structures that they're potentially considering? I mean, I'll tell you on the M&A side, one of the things that we are seeing a bit more of is, as opposed to considering a hundred percent sale for a large asset, because sometimes they actually like these assets and they'd like to hold them longer. We've certainly, over the last few years, seen continuation funds be a vehicle that allows sponsors to keep holding an asset but monetize a portion. They've also just plainly sold a percentage, even 50% of an asset to another financial sponsor and maintain their ownership position, whether in an existing fund of their portfolio or in a newer, younger life fund, just so that they can extend the life as well.
And in those scenarios, I think they've worked really hard to maintain the existing capital structure because it's so advantageous relative to having to refinance.
I mean, how are you seeing some of the different equity structures, because I know we've talked about this, try to account for that in terms of whether it be funding ahead of an IPO or the like or anything like that that you're seeing in your market?
John Kolz:
You're right with the premise that the companies of course are bigger, whether that's a result of just being a little bit later in their life cycle before IPO or some of the other cross currents there.
And so to put that in perspective, the average market cap of an IPO this year is six and a half billion. That compares to an average market cap that's been more like 4 billion for the last four or five years. Again, that's off a very small n, number of companies that have actually gone public, but the thesis is born out in the data that the companies that are coming public are bigger.
The notion of how do you marry that with changes in execution and approach and products is actually, I think, one of the benefits and one of the things that will help us to reopen a more healthy market.
So what do I mean by that? One of the complaints of the buy side right now is the deals are too small. They're too small as a percent of market cap. They leave a big overhang. They're too small. And then also maybe too concentrated into hands of investors that aren't locking arms with new investors.
And so to oversimplify, most public market investors want bigger deals with more liquidity and a price that's reflective of where that bigger amount of size actually clears the market.
So I think that's something that's necessary to find the supply demand equilibrium we keep talking about.
And the other couple of things that I do think we will see in 2024 to help kickstart this reopening, I think historically we would see mandatory convertibles or mandatory preferreds alongside of IPOs. It wasn't used tremendously often, but it was one of those products that helped bridge the gap in size, whether that's size needed to get to a leverage level in the public markets that equity markets want or to actually just fill size because of the scale of the companies that we have. So we could see that.
Overall, the other tactic that's been used and I think is being debated right now, is the use of either pre-IPO or cornerstone investors in IPOs, where you'll launch a deal with much of it already spoken for.
The issue has been that that has been done somewhat from a position of not weakness, but maybe a little bit more of a fear, of still uncertainty in the marketplace, in trying to protect against an outcome that you don't want, as opposed to doing it from a position of strength and finding the right size out in the marketplace and the right market structure.
I think that's one of the evolutions we need to have, not a, I have three investors on my cover because I'm scared of what might come from the public marketing process to, I would've done a $500 million IPO, but in fact I'm going to do a billion dollar IPO and still put 500 into the market like I should have anyway, but have another 500 with cornerstone investors.
Vito Sperduto:
John, as you think about cornerstone investors, I'm curious, I imagine that is something that initially started from the sell side perspective, meaning the company's looking for that, the banks looking for that, to solidify and create a base of stability going into the offering.
Have you seen that dynamic shift at all? Because I imagine with less product out there and institutional investors sitting on large dollars, are they more readily trying to find opportunities to be a cornerstone or is it still a very sell side driven process?
John Kolz:
A little bit in between, Vito. And what do I mean by that? If you could see me on the screen, you'd see me smiling a little bit.
At the height of the IPO market, recent IPO market, before we had had the dramatic downtick in volumes over the last few years, big tech companies in essence were running auctions for investors to see who could have the privilege of being their cornerstone investor.
And it was used to offer investors a ability to get more size, and the corporates were trading price for size to investors who needed more size.
It should have been, and frankly was to many of us, in hindsight at least, was the signal that we have gone too far, when you're auctioning off someone who can spend more at a higher price.
More recently, as I mentioned, the cornerstone process has been more defensive, has been done more to protect against outcomes that you were fearing in the IPO market. I think we need to get back to an equilibrium to where you are really finding investors who want to make a long-term bet and are doing that with a partnership mentality with, I want to partner with this management team for the long term and I'm willing to do that by expressing it earlier than in the public process. So I think we need to get back to a little bit of an equilibrium.
Larry Grafstein:
John, looking forward to 2024, talk to us a little bit about sectors that you're watching and also maybe some of the next generation of potential public companies specifically that might be very interesting from an IPO perspective.
John Kolz:
That's one of the dynamics I think is shaping up to be reasonably healthy, meaning historically, the IPO market in particular was dominated by tech and healthcare and maybe to a point where it got a little bit unhealthy.
What we're seeing now is a much more balanced group of companies. We've obviously seen very big consumer retail companies. I think that's one of the dynamics of the reopening of the market that will prove to be healthy.
What I mean by that is we see representation from many more sectors on the horizon. Historically, the IPO market has been dominated by tech and healthcare, and within that, biotech.
What we see now, and we've seen evidence of that even in 2023, is much more balanced sector representation, whether that's consumer retail, whether that's in financials, there's a wave of, not quite FinTech, but pure financial companies that operate with a technological bent to them.
We have industrial resurgence in many different sub-verticals. Energy, of course, with everything unfortunately going on in the world right now, energy has come to the forefront in issuance volumes again.
And one of some of the sectors that have been impacted the most as a result of rising interest rates, whether that's REITs and financials to a lesser extent, as that balances itself more out, we expect more issuance from those sectors.
So I think it will be more balanced and there are, again, bigger companies that have more representation across sectors, which is more interesting to buyers.
One of the things that gets lost sometimes, frankly, by people like me in equity capital markets, we talk as if the end investor is a software investor or they're a restaurant investor. The vast majority of investors are running funds that can buy many different and do buy many different sub-sectors and would prefer to have more balance. If you run the growth fund at XYZ mutual fund, you want to get growth from many different sectors, and I do think that's something we expect for '24.
Larry Grafstein:
What are some of the companies specifically that are on deck
John Kolz:
Larry, there are a number of companies that have publicly filed and said, I'm preparing for an IPO, and some that have told the world that they've done that, even though they haven't exposed the prospectus publicly.
So some of the bigger ones that are on that list, in no particular order, Stripe, Klarna, Databricks, Reddit. Panera Foods is out there. OpenAI. We can't go a day without hearing something about AI. I'm frankly shocked we've gone 10 minutes talking without talking about AI. Fanatics, et cetera. There's dozens and dozens, of course, of biotech companies that are out there doing some wonderful things in the marketplace that, as human beings, we should all applaud that they continue to get funded and get the cash that they need to run their trials. There's some wonderful science out there that will come to market.
Larry Grafstein:
Yeah, needless to say, that's a very impressive list of important companies. So it has to be a source of optimism.
Vito Sperduto:
, John, as you think about that list of companies, I mean, one of the things we've seen become more the norm when we're selling a business in the M&A context is doing, quote/unquote, "early look meetings," where we're trying to educate potential buyers that maybe aren't as familiar with the business and get comfort with the management teams on a one-on-one basis in a very short meeting versus just going out with a full information memorandum and that being the first time they're exposed to the company.
How are you seeing the testing the waters meetings? Is that becoming more the norm? Are the companies that you mentioned already getting into those sessions, given that they're considering the market next year so that they can have better information? I mean, how has that portion of the process evolved?
John Kolz:
Testing the waters is absolutely the norm of any company approaching the public markets.
That said, it's gotten a little broken and has to evolve to be more productive for both the companies and for investors.
What do I mean by that? It had... Testing the waters had gotten to the point where it became a check the box exercise, and the companies thought that the only thing they were getting out of it was a perfunctory, yeah, I might be interested. Call me when you launch.
And investors thought that they weren't getting enough information to have any reasonable feedback that was constructive for the company or for themselves.
And so we've got to evolve it to meet somewhere in the middle. That likely means starting a little bit earlier and it likely means more touch points with a smaller number of investors that can have real impact on the way to an IPO.
that's one of the things I think me, personally, and RBC, in particular, are trying to ensure that we bring to the party, which is a real process that allows you to approach the markets with more information, therefore less risk, therefore less ability to get price wrong or size wrong. And also to really have a set of investors curated that fit with what the company wants to achieve. And that's everybody's goal. Everybody wants to have those things happen. So it's one of those places where there's no debate as to the outcome desired. The only debate as to how do you get there.
Vito Sperduto:
Well, John, just in wrapping up, obviously we've got many years of experience on this podcast right here, and we've all seen various periods of disruption in our careers in the markets, whether it was going back to.com bubble, the global financial crisis, and other significant time periods.
And there's always been a category that leads us out of that disruption. Sometimes it takes a year or two for it to happen, but for example, right now, on the M&A side, we're seeing well capitalized corporates take advantage and certainly doing some noticeable transactions and consolidating in their spaces and building upon their valuations in a period that maybe their growth has been challenged and they're using their strong financial positions to really be leaders right now, especially when there isn't as strong of a financial bid for assets that they're pursuing.
As we look to '24, I would tell you that the strength in the first two quarters of '24 in our view seems to be, and we expect to more come from the financial players because of the pent-up demand, because of the assets they've been holding longer that are larger and more high quality. How are you thinking about that in the equity markets? What's going to lead us to a opening or to an expansion of the equity markets?
John Kolz:
I think, Vito and Larry, that it'll be quite analogous to what you are seeing. The '22 and '23 IPO market does include some very big corporate IPOs. Kenvue from Johnson and Johnson. Mobileye from Intel. Obvious examples and some others. So it has that analogous been a little bit dominated in that regard.
I do believe though, that private equity leads the market reopening as well in the equity side and will dominate flows. They have always accounted for in one way or the other, 40% or so on average of equity capital markets volumes that could be slightly higher in '24 and beyond, for the reasons that you mentioned. There are many very good high quality assets, some of which have gotten too big for anything but an IPO that have to start an exit process.
And so I do believe, as you both do, that private equity will be a crucial driving force in '24 and beyond.
Vito Sperduto:
Well, look, John, it's been great to have you on the podcast today. I think it's great to hear your expert advice, especially in terms of what we're expecting in '24.
I think from an M&A perspective, Larry and I, and it sounds like you, from an equity capital markets perspective, expect that there will be a window that's open for our clients, and it seems that there's going to be an opportunity to consider multiple alternatives from a monetization perspective, especially if there's assets that they've been waiting to access the market with.
So pretty excited about the volumes that we're anticipating at the beginning of '24. Certainly we're all looking closely at what the year is going to hold and what some of the current strife we're seeing globally and how that's going to impact things going forward.
But it's always helpful to get your expert view on it, and we look forward to talking with you again in the future. So John, thank you for joining us today.
John Kolz:
Thank you, Vito. Thank you, Larry for having me. It's been a real pleasure.
Larry Grafstein:
Really interesting discussion, John, at a particularly turbulent time. Thank you very much for joining us.
Vito Sperduto:
I'm not going to use any bad puns with Taylor Swift songs, but thank you, John.
John Kolz:
Take care.