Vito (00:05):
Hello and welcome to Strategic Alternatives, the RBC M&A podcast. In each episode, we explore trends that are shaping tomorrow's global mergers and acquisitions landscape. I'm Vito Spto, co-head of global M&A, and I'm joined by Larry Grafstein, deputy Chairman of Global Investment Banking. Hi Larry,
Larry (00:25):
Nice to see you.
Vito (00:25):
Now, today we're gonna be joined by a special guest, Jason Gurandiano. Jason is the head of US Technology investment banking, and the global head of FinTech coverage here at RBC Capital Markets. Why don't we start off, Larry, maybe just putting 2022 in perspective at a high level,
Larry (00:43):
I mean 2021 certainly feels like a high watermark as we sit here today. It felt like that at the time and as we've discussed in 2022, there was one set of factors that was highly expected, which, which is the consequences of the Fed raising interest rates from generational lows. But then there was the unexpected event of the war in Ukraine, which was very unfortunate, you know, from a human perspective, but also had a number of secondary effects as particularly as we were coming out of Covid. So I think as we look ahead at 2023, the conventional view is it's a little bit of a mirror of 2022 in the sense that we expect the first half of the year to continue being a little slower and the second half of the year to pick up, particularly once the Fed gets through its interest rate hiking cycle.
(01:31):
But when I look at it, try to look at it in historical perspective, I still believe 2022 was a very strong year. There was still strong deal volume in in different industries. There was still relatively high dollar volume of mergers. There was a slower decline in Europe despite the impact of the economic fallout of the war. And you know, when you take a step back, it just reinforces the notion that we've always discussed, which is good deals will always get done even in difficult environments. We certainly don't have the types of tailwinds that we had a couple of years ago, but nevertheless, M&A remains an integral part of the strategic landscape, a key capital allocation decision and one that you know has a certain or forward motion even in the toughest environments.
Vito (02:20):
Yeah, I mean you and I have been at this for over three decades. You certainly know that M&A is always a central point in terms of the strategic alternatives that are being considered by our clients, whether they're corporates or private equity firms for their portfolio companies or just in general. It was pretty interesting to see when you look at the market on the corporate side, that's always been the driver of whether we think it's a strong M&A cycle or not. Last year about 55% of the volume was generated by corporates. Traditionally when you look back in 21 for a record year, that was 60%. What we did see was a broader participation cuz last year we had a fairly significant increase in deal count and then on the private equity side, sponsors had their second largest volume in history in terms of L B O activity and that's a pretty interesting statistic just given the fall off and the second half of the year.
(03:17):
And tech, as we're about to talk about, have accounted for about 30% of that. Now, when we look forward to 23, I think as you and I have discussed, we think the baseline for 23 is the performance that we saw in 22. So if you think about a general M&A market globally, we had about a just under a 3.7 trillion announced deal volume globally about 1.5 trillion in the US Those figure to be the baselines for 23. And I think there is a good potential for this to be a year where we see an uptick of 10 to 15% versus last year, which would make it a top five M&A year. You just gotta keep it in perspective 21 was so outsized that it's hard to think about that as just an individual year. The other thing we're seeing is last year there was a 21% increase of private capital that's available from a dry powder perspective.
(04:15):
So just under 2 trillion of dry powder sits in private equity funds and in venture capital firms. So that 21% increase, it's twofold. One is I think there were some very significant capital raises, but at the same time, I would say in the second half of the year we didn't see as much spend as we would've expected. There are dollars that are waiting to be spent. So I think that goes along with something I believe is going to happen, which is that the dollars per transaction in terms of LBOs, in terms of other transactions in in a similar fashion are likely to be higher in 23 and forward because of where they are in their fund life and the fact that they wanna spend dollars that they didn't get to spend previously.
Larry (04:58):
Yeah, and look, we also have a bit of uncertainty in early 2023 as to how the economy will react to the very rapid increase in cost of money and the quantitative tightening that the Fed is implementing in addition to its interest rate increases. And of course that can be a headwind to activity and a barrier, but it also, you know, recessions or gross flow downs also for public companies create tremendous boardroom pressure to really be ruthless in your assessment of the overall enterprise. And that can include whether it makes sense to reconfigure your portfolio if you are a diversified company. And it can also raise issues as to what kinds of things you might, moves you might have to make in order to, to protect your position. So if you're a private equity investor sitting on some of that dry powder you just mentioned clearly, if you can find the right asset and put money to work, this is a better time than doing it at peak valuations.
(05:58):
When you talk to our friends that work in the world of sponsors, they often say that your most important decision is the price you pay going into a deal. Another factor, since we're talking about technology today with our US head of technology banking, Jason, technology itself beyond the technology sector is a big factor in structural M&A for industrial companies, consumer companies. And again, as we go into this, you know, perhaps tougher economic environment, technology actually plays a role in forcing companies to question the status quo and review their strategic alternatives in a very proactive way.
Vito (06:36):
And if we pivot the technology space, certainly as I mentioned earlier, it dominated the landscape in terms of deal making in 22, I think the exact figure was something on the order of 37% of all transactions in the M&A space were technology related. There was a strong spike in terms of the number of transactions. And then when we look at sort of the top 10 deals, which by the way, seven of the top 10 last year occurred in the first half of the year. You have, as we mentioned earlier, Microsoft, Activision, we certainly have VMware sale to Broadcom, you know, and obviously the Twitter transaction. And so again, very technology heavy. I think, you know, it's gonna be difficult getting some larger deals done both from a valuation perspective, financing perspective, regulatory perspective, but we certainly see a lot of the tech players being very cash rich and ready to do transactions. And so Jason would would love to maybe get some perspective on what you're seeing with your clients broadly in tech, but maybe also specifically on the FinTech side as we drill in because uh, you've had a, a great start to the year. I think your team has announced some very high profile transactions that are helping to drive the market.
Jason (07:49):
Thank you Ito. I think tech is set up for an outsized year from an M&A perspective and it's really a function of a couple of factors. One, if you look at the macrodynamic that uh, Larry has spoken to, there is sort of increasing certainty or at least visibility as it relates to the macro environment, both from a rate perspective, but also I would say some of the concerns around, you know, where the economy is going and how that would Im impact earnings are being mitigated with regards to some of the reporting we're seeing from public companies in particular. Uh, secondly, M&A tends to thrive in environments where there is sure footing as it relates to valuation. What do I mean by that? You know, M&A struggles and scenarios where there's volatility in multiples, there's volatility in valuation and that was really what we saw last year boards, now that they have comfort around valuation and have, you know, many cases clean balance sheets and access to capital are leveraging that to their benefit to acquire crown jewel assets.
(08:52):
I would say in our conversations with public company boards, they do see sort of a window in time here where for the first time in a number of years they're able to compete with private equity who up until recently was able to take advantage of very low cost of capital and outsize debt packages to Trump the strategic bid. Whereas historically, as we all know, synergies through strategic transactions should in theory trump a standalone private equity type dynamic. On the private equity side of the equation, we're starting to see them reengage. The debt markets remain challenged as banks sit on numerous commitments that are underwater, but the private capital markets are stepping in to fill the void. And we're seeing sponsors in particular over equitized transactions to, you know, from a competitive dynamic perspective to own assets that they feel have real upside potential in a recovery market. And we saw an example of that with vista's take private of Duck Creek. Duck Creek was interesting in that it was an I P O at $27 there was announced takeout price at 19 and as boards sort of get comfort around the ability to transact at levels below I p o prices or even 52 week high, I think that's gonna open the floodgates for further activity both public to public, but also on the take private side.
Larry (10:11):
You know, that's an interesting point Jason, because the i p o market in 2022 was really one of the worst i p O markets we've seen and we're all hopeful that I p o activity can resume. They're certainly pent up demand and that conditions can be better and stronger for IPOs as we hope they will be for equities more generally. But we don't know exactly when that will happen and the I P O market can be slow to come back sometimes. And so that actually changes the dynamic a little bit for certainly private companies because often in a strong I p O market you can consider an I P O as one track and, and a divestiture as a second track. We dual track processes, you know, are very common now. There's really only that one track at the moment, but as I p o activity comes back that could be part of market repair and could be part of valuations being enhanced.
Jason (11:06):
First off, I, I completely agree with you. I think private equity has been, you know, extremely active in tech and FinTech over the last five to seven years. There's a number of companies that have seasoned within the portfolios of these private equity firms and where private equity firms need exits typically, you know, if you were to roll back the clock 18 months ago, you know, our pitch to private equity firms and their portfolio companies would entail triple track, right? So it'd be I p O versus SPAC versus M&A or sell side. What's amazing is obviously with the fall off of the SPAC market, that is not viewed as an attractive or viable path. So we've removed one track, the I P o markets are shut, or to the extent that you do wanna brave them, you would've to go ahead and significant discount.
(11:54):
So M&A is often the only track to pursue monetization. The other interesting element relates to valuation because if you remember when we were doing these doula triple track processes, often the bid ask was Company X, you know, can IPO at, you know, a one year forward multiple of X implying a value of Y and the M&A bid, you know, typically did not give full credit for that one year forward look through. And so you had a bid as differential between the two and in many cases the obvious answer was, well I'll just go public, right, because I'll take full advantage of getting full credit for the multiple and frankly probably less scrutiny as it relates to my four projection than it would in M&A context.
Vito (12:39):
Yeah, no look I, I'd agree Jason, and I think what we're seeing is if I think about the clients in the private equity world that we've been talking to, they've certainly been pursuing more of a portfolio or platform strategy, however you wanna refer to it. They are more thinking about what are the alternatives across a specific portfolio company in terms of maybe there's businesses that they can separate out of it, they're considering whether to divest pieces of it first before monetizing the entire company. And I think that's a matter of, you know, maybe the, some of the parts is greater than, than the whole and they're certainly evaluating that because one of the things we're seeing is hold times feel like they're extending. And a lot of that has to do with the fact that there are some of the alternatives that they would normally consider the I P O market, maybe even a refinancing market, aren't as readily available as we talked about.
(13:35):
So what it's producing is a lot of opportunities right now in this current window where they're considering alternatives that are slightly different than they would normally. And that's the case also on the corporate side as well. Corporate divestitures are always the leading category in terms of M&A transactions and so that's something we're seeing obviously out there. But in terms of the transactions that are getting done today, a lot of 'em are technology focused because that's where the funds are more focused. I think they're, technology has always been a, an area that all parties are looking at and trying to figure out how it ties into their business. So I do think we're gonna see continuously the activity there. Yeah,
Jason (14:21):
We've seen an uptick across the board. The sweet spot from where we sit today is kind of in that 500 to 2 billion size range, both public and private simply because those deal sizes tend to be sizable enough to move the needle even for the largest of enterprises, but don't have a risk profile such that, uh, you're taking on asymmetric risk as it relates to, you know, the deal working out or the market's reaction to, to said deal. And that lines up very nicely with the Neve deal being in and around 1.3 billion, duck Creek being slightly larger, 2.6 billion with regards to the type of transactions. I would say if you have a platform that is geared towards M&A, either public or private, now is an opportune time to engage in M&A discussions and sort of take the crown jewel assets off the chess board because the worst thing that could happen, especially as a founder entrepreneur, is you have a situation whereby you flog it out for the next three years.
(15:23):
You deliver on your numbers as you plan, but you know, your multiple stays stagnant or even goes down and you have a situation where it's value neutral, value destructive, and you have a lot more gray hairs on your head or no hair depending on who we're talking to. Uh, so I think that's, that's definitely top of mind and you know, an element and a central question, a gating question for a lot of management teams, private equity firms where they have to really have an honest assessment like, is the juice worth the squeeze? And in many cases it isn't.
Vito (15:51):
Yeah, I think we're all having conversations with multiple clients trying to bridge valuation gaps and whether it's a seller or a buyer, public or private, and really trying to think about where is value today. The parties that are well capitalized, whether they're the the private equity firms or the corporates, this is an environment that is ripe for opportunity and you're gonna see those parties that are better positioned take advantage. And so we've seen the leading private equity firms, we've seen the leading corporates, they're out there and they're looking to see how they can bolster their business, whether it's adding complimentary technologies, whether it's some geographic expansion. I mean, we haven't talked about supply chain diversification, which is an important theme for many of our clients, uh, especially on the technology side to make sure that they can avoid some of the issues with geopolitical instability. In some cases,
Jason (16:48):
FinTech is a unique animal in that it is the domain of large established incumbents, you know, people like RBC and you know, I think it's underappreciated how big the technology spend is at an fi such as ourselves. We on average spend about 4 billion a year on technology. So we are a major developer, user buyer of technology across the board. And then on the other side of the equation, you have, you know, a number of disruptors who, you know, tend to be nimble, are able to develop quicker and are pushing the envelope both as it relates to user experience or processing speeds or efficiency. And so that's kind of been the mismatch, right? The challenge from an M&A perspective in FinTech has been the incumbents trade at traditional multiples that are modest at best, even in the best of environments versus situations where, you know, up until recently you had a cohort of best in class technology companies that were trading at, you know, double digit multiple revenues on a forward basis.
(17:48):
And so that was always the mismatch there was the industrial logic was always clear as it relates to why a number of these companies should be together. The established incumbents provide benefits such as regulatory frameworks, scale and otherwise, but the valuations never matched with the degradation of value. And with some companies running up against, you know, cash burn walls, it's created a fertile opportunity for, you know, large incumbents to potentially jumpstart their development efforts or their milestones from a technology perspective, or frankly even acquire things at a better price point than they'd be able to develop them just from an M&A perspective. To bring it back full circle, you know, part of the, uh, part of the challenge of the private companies is when they articulate, you know, their valuation, you know, either public companies or private equity say, well that's all well and good, but I can buy your much bigger closest comp at a 30 to 40% discount than the number you're quoting me. And so why, why should I bother with you if that's where your head's at? Like I have a real-time price discovery in the public markets often for companies that are much larger than where, than where you are today.
Vito (19:01):
One interesting thing that I know, Larry, you and I are watching is how soon are corporates able to use your stock as a more effective currency in transactions? If you look at it, I think the statistic, if I recall correctly in 22 is that only 12% of transactions in all of 22 done by corporates were stock only. And that is the lowest level we've seen in history other than in 2017. To put it in comparison, usually we're seeing the stock only transactions at about a quarter of the market in terms of deals, and we've seen a significant uptick in cash. Only about 78% of all the transactions last year were pure cash only in terms of how corporates executed deals. So I do expect that the percentage that are gonna be stock only, it's gonna ha uptick, but not dramatically, but it just highlights sort of certainty that folks are looking for.
(20:01):
It also highlights in this market the importance of communicating a proper strategic rationale for the transactions that are being announced. And if we look at the depth of commentary that's being given in the announcement of transactions by public companies, they're really trying to paint the story in terms of the extent of the work that they did to get to the place where they ended up, why they feel this is a strong transaction and how it positions it relative to history. And it's almost doing the work that you're gonna see in the proxy statement at the time of announcement.
Jason (20:37):
I think the buy side is very wary of transactions and they're very wary of the dynamics that we talked about earlier whereby is this transaction happening, you know, to create long-term value for all stakeholders or is this a short-term fix to potentially mask other challenges in the acquiring business, you know, through synergies or otherwise?
Larry (20:57):
Well, and that's one legacy of 2022 that will persist not just for this year, but probably for next year because the whip saw effect of going from not just risk on but truly risk tolerant to risk averse, you know, was very sudden because of the, just the rapidity, uh, of the reversal of of the interest rate policy
Vito (21:21):
Overall, the technology sector, much like some others. We're seeing some news that's weighing down. I think there's, you know, certainly a focus on the amount of layoffs and cost controls that are being put in place. I think you gotta keep that all in perspective relative to where these businesses are today. And if you were to compare it to where they were pre pandemic, let's say just three years ago, they're still up in terms of number of employees. They're dramatically up in terms of performance. Um, and so those are, you know, items to keep in mind. And I also do think that there's a greater focus right now on what's happening internally just to make sure the businesses are set up and are operating as efficiently as possible and they're getting the most out of the assets that they have from a transaction perspective. There are certainly some deals that were done primarily for financial engineering or near term results perspective that have not proven out as strongly as they could. And it just highlights the fact that you need to consider all the different stakeholders as you're doing a deal. And really it's gotta make a strategic rationale that can be easily communicated and make sense and good strategic deals get done, which we're gonna say many times during this podcast. Well,
Jason (22:34):
Maybe to summarize, we should provide our outlooks for 23 from where we sit today heading out of 22. I think there was the broader perception that we were kind of, you know, at the bottom or heading towards the bottom of a VC curve. And so, you know, the first half of the year would be more modest and then we'd see a rapid acceleration through the second half of the year. Uh, so I think a lot of that dynamics that we thought would be second half are gonna be pulled forward into, you know, q1, q2. And so I don't think it's gonna be as gradual sort of slope. I think it's actually gonna turn up pretty quickly here, at least from what I see, especially as the markets get, you know, more solid footing as people get more comfort around inflation coming in line. And as frankly we have line of sight to the fed tightening sort of tailing off a bit. And so I feel quite bullish on the prospects for M&A. As I said, the IPO market's remaining challenge is probably gonna be one of the biggest catalysts for further M&A. The one factor that is still unknown to me that I think could pour a real accelerant to, to the M&A market is, you know, the functionality of the debt markets. I think at the debt markets, any semblance of real footing, I think you're gonna see a large wave of activity.
Vito (23:50):
Look, I would just say that this has been a great conversation and you know, we all are constantly doing work together with our clients across the board and certainly see a lot of great opportunity going forward, not just in 23, but beyond. You've been listening to Strategic Alternatives, the RBC M&A podcast. Join us for more analysis in the second part of our FinTech conversation with Jason Gurandiano in our next episode. Until then, thanks for joining us and if you'd like more information on any of the topics discussed today, please contact us directly or visit our website at rbccm.com. This podcast was recorded on January 20th, 2023.
Speaker 4 (24:37):
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