Vito (00:06):
Welcome back to today's second episode of Strategic Alternatives, the R B C M and a podcast. I'm Vitos Peduto, global Head of Mergers and Acquisitions. As always, I'm joined by Larry Stein, deputy Chairman of Global Investment Banking, and our guest today, Josh Rosenbaum, global Head of Industrial and Diversified Services. Welcome back to the podcast.
Josh (00:28):
Thanks. Good to be back.
Larry (00:30):
Josh. One of the things that's been fascinating, Vito mentioned the incredible up and down of cycles the last couple years going back even before the pandemic, but one of the things we can't resist asking you about is building products where you're a leading expert and the housing market and the effect on all sorts of issues around housing and the building product cycle, which is always very sensitive as it relates to the economy. Give us a little bit of an outlook on that sector and also a little bit of insight as to what you're seeing.
Josh (01:22):
It's been quite remarkable. We all know in 2022 as people were looking at 2023, just like the overwhelming consensus was going to be a very difficult year for the markets, I think people would've said it would be just as or even more difficult for anything tied to construction, which historically has been incredibly interest rate sensitive. Yet here we are with over 7% mortgage rates and the home builders have been some of the best performers out there. The part of the equation historically, it was kind of reasonably airtight in terms of determining the environment for building and construction spaces. Okay, tell me where interest rates are and tell me where unemployment is, and that's really the disconnect is because you have very high rates, but we have low unemployment, so it's very unusual and experts. I've been covering the sector for a long time. People that have been covering it for even longer than I have really haven't seen anything like this, so as long as you have unemployment low and people could cover their payments 7% or otherwise, there's going to be some activity. You also have this nuanced activity, which has made headlines, is that a lot of people that are locked in at mortgage rates that are two and a half to 4%, they're not selling, so there's no supply out there, so any new lots that come on, whatever set portion of the population needs a home, whether it's a job, family, expansion of the family, other circumstances, this is supply and demand.
(02:38):
If there's very little supply, demand doesn't have to be through the charts and that demand will drive pricing, so that's what's been going on. Obviously, if rates come down and unemployment rate's low, this space could get beyond interesting and interesting as it is right now. Residentials holding in there, people are worried about the office. I don't have to belabor that too much, but it's a little bit of a zero sum high rise urban pressure on especially office, but there's a lot of suburbanization offices that are needed. I'm not just talking about huge battery semiconductor plants, but all sorts of onshoring in the industrial manufacturing sector that's helping out, so things are holding in there. Well, it's actually been a pretty good market for building and construction.
Vito (03:28):
Josh, we just had a couple episodes recently where we talked about the changes that we're seeing in the private equity markets and also at how leverage finance is impacting that. I would say that there haven't been as much in terms of monetizations and it feels like they've been holding portfolio companies longer, which is interesting. I was just reading that the average hold period this year is about 5.6 years in private equity portfolios, which doesn't seem like a long period, but it's up about half a year versus where it is traditionally over history. Do you see a strong wave of potential companies coming to the market in 24? Do you think that the equity markets starting to be constructive is helping in that regard?
Josh (04:15):
Yes. I feel that the private equity market, even as we sit here doing this podcast, is moving in the right direction. You're talking about some of the most innovative creative deal makers out there. Most of the deals, the regular way L B O has effectively been for industrials. It has been incredibly dormant since the beginning of 2022. The deals that we're seeing get done are largely deals where the existing seller rolls a lot, so reduces the need for debt or even 50 50 deals where you can keep the capital structure in place. We're seeing a lot of structured paper, earnouts, anything to bridge this badass gap, and I'll go back to the fundamental, this is math. I would say for most of 22 into the beginning of this year, a lot of reasons deals weren't getting done. It's just too much macro uncertainty. If you're making a big bet, especially a lever bet into a rising rate environment with all the geopolitical circumstances, it's kind of like as innovative and risk-taking as private equity may be.
(05:25):
That's a lot. You couple that with leverage, that's a lot to take on. I think right now, as I said, the fears have abated that we're going to a really bad place in terms of performance, so right now it's just deal making. It is just bridging this bid ask gap. It's okay, we've got base rates of 5% plus the junior capital is going to be expensive. It's going to be double digit. We haven't seen that for a while. We got used to the junior capital being as low as five 6%. Okay, so that's the cost of the how do we get this deal done. If you're a private equity seller, the way you do that is you roll a portion of the equity, you maybe take something in the form of an earnout. You get creative there to get to a headline price and multiple that works for you. If you're the buyer, ditto, you introduce structure because the old six to seven times leverage and add on another five to six turns of equity that had been prevalent for years and years and years and was driving multiples. That's just harder to do right now, but I really feel that for a five-year hold, you look out, you feel like performance is going to be good, you're going to see very innovative smart people come up with solutions, structured solutions to get deals done.
Vito (06:39):
Are you seeing them be competitive with the corporates as they're considering buying carve-outs and the like? Because to date, if we look at this past year, I would tell you that the corporates have outperformed the private equity firms just given that they had much better capital to play with.
Josh (06:54):
Absolutely. It was a corporate market. I think for assets where there's not a natural corporate buyer or the corporate buyer for whatever reason is distracted and the buyer's going to private equity. You're having to see these customized solutions, which is good for bankers. It's interesting the bankers could get creative. We've been spending days on a couple of situations just brainstorming on how to bridge this bid ask, but listen, when there's a natural corporate buyer with synergies and their cost of capital, in theory, they should prevail. I think Vito, as you know, on b a E, that was the situation and private equity was looking at it, but at the end of the day, b a e, with their balance sheet and cost of capital, they were going to prevail.
Vito (07:32):
Well, Larry and Josh, thank you so much for the conversation today. Certainly, it's been a great follow-up to some of the dialogue we've had in recent podcasts, especially as we talked about the private equity markets and leveraged finance markets with John COOs and Harold Vera recently. It was great to hear Josh's perspective on what's going on the remainder of this year and into 24, and especially with fresh insight from many corporate CEOs who just attended our Global Industrials conference,
Larry (08:01):
And I was struck by Josh's observations about confidence in the economy generally because there's a very diverse group of companies that his group covers.
Vito (08:14):
So many of our clients have taken the time in the last few years to really prepare their businesses, and so one of the things that we're seeing is that whether it's been through de-leveraging, whether it's been through portfolio shaping, they're readier now than at any time in history to execute on whether it's transformative m and a or add-on m and a, and so that's why we continue to believe that there will be a strong transaction environment through the remainder of this year, but especially as we go into 24. You've been listening to Strategic Alternatives, the R B C M and A podcast. Join us for more analysis about what's moving the m and a markets in our next episode. If you'd like more information on the topics discussed today, please contact us directly or visit rbc cmm.com/strategic alternatives. Today's podcast was recorded on September 18th, 2023. If you're enjoying Strategic Alternatives, don't miss an episode. Subscribe to us on Apple, Spotify, or wherever you listen to your podcasts, and please drop us a review and or comment.
Speaker 4 (09:27):
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