Vito Sperduto:
Hello and welcome to another episode of Strategic Alternatives, the RBC M&A podcast. I'm Vito Sperduto, Global Head of Mergers and Acquisitions at RBC Capital Markets. And as always, I'm joined by Larry Grafstein, Deputy Chair of Global Investment Banking. Hi, Larry.
Larry Grafstein:
Great to be here, Vito, as always.
Vito Sperduto:
Today, Larry and I are joined by John Kolz, Global Co-Head of Equity Capital Markets here at RBC. John has over 25 years of investment banking experience, including in various positions across the ECM landscape. He holds an MBA from the Kellogg School at Northwestern, and a Bachelor of Science in Nuclear and Power Engineering from the University of Cincinnati.
And that sounds pretty impressive, John, but what I'm really impressed with is the fact that, right now, in pop culture, you are the third most popular Bearcat alumni right after the two Kelce brothers. So congratulations, John, and welcome to the podcast.
John Kolz:
Well, it is a distinct pleasure to be here, and I often joke that I think I'm maybe the only UC graduate anywhere on Wall Street, so I'm happy to carry that flag and be compared to Travis Kelce at any point in time. So thanks for that, Vito.
Vito Sperduto:
Well, that's wonderful.
Vito Sperduto:
John, given your tenure in investment banking, especially the work you've done across various portions of equity capital markets in your career, maybe talk a little bit about your background and how you're bringing that expertise to bear with our clients today, especially given the turbulent times that we're in.
John Kolz:
Yeah. Thanks, Vito. You're right. 25 years, actually 26 now, in equity capital markets does provide some perspective and I do think that that perspective is more necessary than ever, both in terms of what has been useful in the past in overcoming, whether it's macroeconomic, geopolitical, pure supply demand, which we'll get into, what's been useful in the past and, frankly, what is no longer useful and what needs to be changed as we think about the marketplace.
So I do draw on that experience every day. One of the things I joke to my own team about, my first IPO that I ever worked on was the eBay IPO in September of 1998, and it seems like an eternity ago already, but that was coming out of a very long drought in the capital markets, post the Russian liquidity crisis. And there's always a cross current that we have to deal with, and I think that perspective that we can bring is certainly useful and something that clients are asking us about every day.
Vito Sperduto:
John, as we start the conversation, let me just back up.
As we get into some of the detail, John, I always think it's helpful to kind of talk a bit about the background in terms of the markets. When I think about the M&A market, and we've always seen this and been consistent in this message, we always thought that this year was going to be sort of a flip of what we saw in '22, where we knew the first half of the year was going to be slow, similar to the second half of '22, but we were expecting more of an uptick in the second half of the year, to bring it back in line with 2022 levels in terms of M&A transaction volume and the like.
We certainly have seen an increase this quarter, in the most recent quarter, the third quarter. It was up 36% versus last year, but it's still not up to the levels that we need it to be, to get to a point where this year is going to match '22.
So we've got some hope going forward, but I think when we look at the volumes, it's still trending at levels that are below where we would've liked it for the year and there's a fair bit of pent-up demand. Maybe contrast that with what you've seen in the IPO and follow-on markets from an equity perspective, especially as you think about the volumes in those markets. I know we've talked about it. You've said it's up, but certainly it's off the press levels.
John Kolz:
That's exactly right, Vito. The volumes on a percentage basis, actually, you'd conclude are very healthy. IPO volumes are nearly triple what they were last year. The broad market in equity issuance is up 20% this year. Sounds like very healthy levels. But that is off a dramatically low, decades long low, in terms of a base.
And so, to put things in perspective, right now we're sitting at an IPO volume of about 17 billion, on average. In the last five or six years, that's more like 50. That's the type of 50 billion. In '21, for example, it was 137 billion. The broad market is at about 130 billion of equity issuance this year, compares to an average year of 250.
So, despite being up 20%, we're still way, way below where an average year would be.
And this gets to the question that probably all three of us spend the most of our time talking about, which is when will things get back to, quote/unquote, "normal," and what are the catalysts to get there? I'm sure we'll get into some of this, a lot of crosscurrents, whether it's supply, whether it's demand, whether it's all the macro things that we talk about, whether it's investor sentiment that is driving things positively or negatively, a lot of cross currents, but we're still, despite being up, way, way off volumes that we'd like to be.
Larry Grafstein:
And I would say, just given the incredible volume of private company activity leading up to this pause in the public markets, pent-up demand levels will be very large.
John Kolz:
Yeah, and Vito and Larry, one of the things I know the three of us talk a lot about because it impacts both of our markets, is where private equity is, and I think it's, Larry, you were telling me, I think, 10-year plus high in terms of the amount of dry powder sitting at private equity. And in my world, private equity normally accounts for 40, maybe 50% of issuance volumes, and I guess that's a tale of two cities. Pent-up dry powder will support not only eventual IPO volumes, but certainly M&A along the way. And there are a long, long... There's a long, long backlog of companies in private equity that are debating the right time to hit the public markets.
Larry Grafstein:
And, of course, venture capital unicorns at levels of all time highs, companies that may never have been public before, but just the surge of private investment into those types of vehicles in the years leading up to the interest rate policy of the Fed reversing, something that we haven't really ever seen before.
Vito Sperduto:
John, when we talk to clients and one of the reasons for the title of this podcast is the fact that we're always trying to keep them fully informed and updated on the different and various strategic alternatives that they have available to themselves and compare those to the status quo. When we're thinking about some of our clients that have portfolios of companies, what are the opportunities from a monetization perspective, it might be an M&A alternative, it might be accessing the equity markets and certainly I think there's been some difficulty there. I mean, how do you think about the pipeline that is sitting there right now? Because it does feel that it's not just a large pipeline, but it's a large quality pipeline of assets and I think everybody's trying to be precise in how they time the markets, yours and ours, but certainly as we've learned over our careers that precision is really hard. But how are you counseling clients in this environment as they're preparing?
John Kolz:
Yeah, I agree with that, Vito. The first point that'd I make is to be prepared. We know windows come and go, but being prepared to hit that window, if a relatively fleeting window, is probably the best advice. That's, of course, easier said than done. But it's something that I'd say we've seen a big uptick in probably in the last quarter or so in terms of just real preparation towards an eventual exit as opposed to talking about it in a hypothetical. That can come in the form of beginning to draft prospectuses or in the form of really getting your accounting house in order or all of the above.
In terms of the backlog though, you're right. There is probably a bigger pent-up supply of higher quality, bigger, more profitable companies than there has been in a long time. If you rewind a few years, we all collectively told the issuing community, you have to be profitable. All of a sudden, the days of a unprofitable, fast-growing company hitting the marketplace are over, to vastly oversimplify. And, by and large, that's what happened.
The result of that is companies that are much bigger, that are in much better shape overall, and that come to the market in a very different format than they would have in years past.
For example, as slow as this year has been in IPOs, we've had three of the six biggest market cap companies come public this year than that have been in the last five or six years.
So we've got bigger companies, we've got better capitalized companies, and overall I think that is starting to provide the backdrop for a healthier market.
Vito Sperduto:
Hey, John, just to round it out a little bit, let's talk about maybe a market that all of us are familiar with, but we are not experts in, the leverage finance market.
And one of the things I always think about is, today we've talked a fair bit about the fact that there is a strong strategic bid for assets, primarily because over the last few years, it feels that they've taken advantage of strong cash flows at their businesses to really get to some very healthy points in terms of their balance sheets.
And so they're better prepared to potentially consider strategic acquisitions and the like. And it's great to have that strategic bid.
But when the leveraged finance market is constrained and there isn't a viable market there, I think it makes the sponsor bid, in an M&A process as an example, not as viable and of an alternative and we've had to see them do other things, which we'll talk about later today.
But how does that market and the strength of that market, good or bad, impact equity issuance? Do you see correlations between the two or how do you think about that as we are advising clients?
John Kolz:
Yeah, there's a couple ways that that finds its way into the equity capital markets. I think it's the mechanism that you just said, which is there a viable alternative or not?
If you get to a scale with an asset right now, there's no alternative other than an IPO, to your point. If it's not going to go a strategic sale, there's really at some size not a profit equity bid that likely works.
On the other hand, the demand from the IPO investors, certainly a demand at a price that is interesting to a seller, has really not found that equilibrium yet. We've talked about whether it's a supply problem or demand problem or both. The real issue is that you have to have a clearing price to make supply meet demand, and I think that's still being debated.
There's an IPO buyer viewpoint that any company that comes public has already run a dual track. We talk about this a lot, whether it's a recommendation or not. Any IPO buyer says, especially from private equity, that they would much rather have sold the company than taken it public, so they're going to assume, whether correct or not, that if they're going public, that meant there wasn't an alternative to that.
And so I think whether that finds its way into the IPO buyer psyche to say I have more leverage because they have no alternative but to take it public. I know that also means for private equity in particular that it's a multiple year journey from the IPO to actually sell down.
So I think there's a little bit of that that finds its way into the price negotiation as well. I don't think we'll ever have it perfect, but it's there. It's certainly there.
Larry Grafstein:
Just to clarify, by dual track, you mean a process whereby an owner of an asset considers in parallel possible IPO as a monetization exercise or possible sale of the whole company?
John Kolz:
Exactly, exactly. The buyer of an IPO will assume that the seller, if it's private equity in particular, that the seller would have preferred to sell the whole company and has gone down that path and concluded that they're better off going to the IPO market.
Vito Sperduto:
John, as we think about alternatives, oftentimes we'll see that if we think there's a value from an M&A exit perspective, certainly there's a relationship between that value and where you potentially would price an IPO.
Similarly, I would say I've noticed a number of clients are putting a higher discount on the future exits that they would need if they were to take a company public because it's going to take multiple rounds of follow-on offerings and sell downs to actually monetize the position.
And so it seems to me like they've increased the discount that they're considering in those situations if they're valuing it to the present to be able to compare that alternative, given the volatility in the market, given the likelihood of institutional investors being there. I mean, are you seeing the same? Or is this just something that happens in turbulent periods and then comes back?
John Kolz:
We do see that and it's only natural and it's another one of the many outreaches from what has changed in a different interest rate environment that we haven't seen in a very long time, that simple, when do I get my cash returned? The further out that is in a higher interest rate environment, is worth less today.
And couple that with the fact that the IPOs that we have seen have been generally smaller, as a percent of market cap, than they had been historically. We can debate whether they had to be to get done or not, but if you're selling less of the company today, that elongates the time to when you fully exit at a higher interest rate, worse NPV. And so that absolutely factors into things.
In general, I'd say historically the data would've showed from IPO to full exit two to three years, between first follow-on, second follow-on, then moving to block trades. That's probably elongated now in reality, given the starting point being smaller.
Larry Grafstein:
And some of that has to be related to the fact that multiples are always inversely related to interest rates. And so, as we all await the end of interest rate increases, there's a hope that perhaps they'll settle out, maybe moderate, which would lead to multiple expansion.
But I do want to come back, John, to something you said about some of the recent deals being smaller. Let's talk about some of the high profile deals.
Traditionally, when an IPO market is shut down, then it reopens, you need some leaders. You need some positive examples of that. And we've seen some very sizable companies, like ARM, owned by SoftBank, like Instacart and a number of others. Birkenstock recently, a well-known consumer brand. Tell us a little bit about how those IPOs are doing and what the effect is on the market right now.
John Kolz:
Yeah, Larry, you're right. There was a number of big high profile IPOs that arguably had too much pressure on them, too much attention, and carried too much weight of are these going to be the ones that reopen the IPO market?
In general, I'd say the good news is they all got done and were completed.
The less good news is they have all performed somewhere between below expectations and simply poorly in the aftermarket.
The question becomes why? Were they mis-executed? Were there misjudgments in price, in tactics, in receptivity? All of the above is the answer. There's no single answer.
But the question you asked on sizing, connecting back to where we were, it seems like an obvious tactic that if you want to, if you're a little more worried about IPO certainty and IPO execution, do a little bit smaller of a deal, have more of that spoken for on day one versus having to go out and find new investors, that tactic sounds logical.
In reality, it's likely backfired. The investor base right now wants bigger deals with more liquidity, with more of a lockdown mentality spread among high quality like-minded investors.
And what they've got instead is a sort of a bifurcated, a group of investors who are already circled at the time of launch, that presumably are rock solid and will add more in the aftermarket, and then some new additions to the club who are told, Hey, you get to join this exclusive club.
What it has ended up being is that neither side got what they want, and it has produced aftermarket outcomes that have not been inspiring to reopening the IPO market.
The average of all of the IPOs this year is flat. And that includes some very high profile returns of very small deals. If you did it dollar weighted average, dollar weighted average, it's dramatically negative. So if you're the buyer of IPOs, which is supposed to be an IPO class that adds alpha to your portfolio, that is priced with a discount to take the risk of going from no public liquidity to public liquidity, and it hasn't happened.
So that is somewhat what I referred to at the beginning of the pod of rethinking some of these tactics and whether we need better mousetraps to how to get deals done appropriately.
Larry Grafstein:
So summarizing your very keen insights on this, maybe we could say that a number of the things that happened in 2023 so far were necessary to preconditions to the IPO market opening up in a healthy, robust way, but not yet sufficient.
John Kolz:
That's perfectly said, Larry.
And I think it also highlights that these few IPOs, whether it was Arm or Birkenstock or Klaviyo or Instacart, which are the four that are most often discussed because they were the biggest and most high profile, that those in some ways are anomalies and not the fat part of the bell curve of what we want to see in the IPO market, the return of the... in any given year, tech and healthcare account for 30 to 50% of the IPO market. Tech in particular has been largely absent, and it's the classic 250 or $300 million IPO, not the billion dollar IPO that has been missing.
Larry Grafstein:
And Vito and I would say that while there's been some repair in the calendar 2023 to the M&A market, it hasn't really come back in a way that you see high-end multiples pushing the envelope. We feel better about where things stand and what the outlook is, but there's still some headwinds to M&A as well.
Vito Sperduto:
John and Larry, maybe let's touch upon some of the economic indicators and geopolitical issues that are impacting our markets. And, I mean, obviously, as we think on the geopolitical front right now, what's going on in the Israeli/Hamas conflict, is having some meaningful and lasting impact to populations in the Middle East and across the globe, and certainly that's something we're all mindful of. And it's not just simply about how it's hitting our markets. So it's always that's first and foremost of what we're thinking about.
We're sitting here and we're recording this today in mid-October, and we've got a number of issues that are impacting things.
Larry and I always talk about CEO confidence and how that conveys to being able to make decisions on M&A transactions, but certainly it impacts being able to do equity financings as well.
We always look at the Conference Board CEO survey, and in their most recent survey at the start of this month, it was basically flat to slightly down from last quarter, which is up versus the prior four quarters, but certainly the confidence levels are cautious.
And when they're looking at it, I think there's still an expectation across the majority of CEOs that were surveyed that they expect some form of a US recession, but at the same time, three quarters of them expect that it's going to be something, if they do expect it, they expect it to be short and sort of get through it quickly. Brief and shallow, I think is the terminologies they're using.
We often talk to a lot of our clients and as they're trying to make decisions, give them guidance on what we're seeing in the market and sort what indicators to look towards. I mean, John, how are you giving counsel as clients are trying to decipher? And maybe we start first with some of the economic indicators. On the day we're recording, today, I know Powell is about to speak and certainly inflation remains high and how the Fed deals with that, I think everybody's very curious.
John Kolz:
We lived through a time where we didn't have to worry about what the Fed chairman said for a while. We weren't parsing every word in the speech like we were 10, 15 years ago, and now we're back to parsing every word and seeing exactly what has changed. And that certainly impacts both the CEO confidence and CEO psyche and boards owners as well as investors.
The probably biggest, most palpable view out there is, at least from the buy side, is no investor right now feels like they're going to miss something and not have an opportunity to buy it again. It permeates to, do I have to buy this deal today? Do I have to buy this IPO today? Or yeah, maybe if I miss it, I'll be able to get it back, but I'm certainly not going to miss out on an opportunity, and it gets to conviction level.
On the other side, back to the supply/demand discussion, for the earlier part of '23, many of the CEOs that we talked to said, even if I could go public, I don't think I'm quite ready yet. I'm not sure that I've got a full handle enough on my business to be able to say, when we tell them, you better be darn sure about your first quarter out of the box and your second quarter in particular, I think some CEOs, I see some heads shaking, I see some CEOs just didn't have that yet and realize that they needed a little bit more time. And that starts from the macro, that starts from this view of what does the broad economy that impacts every one of these companies look like?
Vito Sperduto:
John, it's interesting, we often talk about the fact that a lot of our clients feel some strength in their business, but they're still nervous because they've been told that the market's difficult. And they talk about the fact that, well, my business is doing well, but I know my competitors aren't doing as well and I'm concerned about the economy.
And so I do think whether that's reality or not, and they all kind of feel that way, it still creates an environment where there's a lack of confidence that allows them to be resolute in making decisions.
But certainly I think they're looking for some signals and it's tough to point to specific issues right now.
Larry Grafstein:
So I'll just say, obviously, right now, a time when, if you're a decision maker, you're very concerned about exogenous shocks. And, of course, we all hope that these wars don't widen. They've already had terrible human consequences.
But leaving aside the unpredictable, John, one of the things that is predictable is that we're heading into a presidential election year in 2024 and politics can be a very volatile time in the market.
So explain to us a little bit how we should think about the presidential election year from the standpoint of the equity markets?
John Kolz:
Yeah, as if we didn't have enough things to contend with, we throw election year into it, and as we all know, that seems to start earlier and earlier every election cycle. The knowns, of course, of the conventions, which I believe are July and August, are there. And then, of course, the rhetoric and the polarization, we're already seeing it and is likely to crescendo even further.
The data would show you something that is a little bit more optimistic. So we've gone back, and I'm staring at it now, gone back for the last dozen or so election years and all but two are actually positive S&P returns. The two that weren't, you could debate, had nothing to do with the election itself, 2008 and 2000.
That said, non-election years are generally better than election years, even though mostly still positive. And issuance volumes certainly take a little bit of a dip, because right around the election itself, nobody wants to be the one out in the market that is contending with that.
But overall, it's not as big of an impact to issuance volumes as you would expect. So I think there's a reason to be optimistic. That said, I don't think we can ever disentangle some of the issues that we talked about, whether it's macro or geopolitical or just investor sentiment or CEO confidence, how that all impacts volumes in both of our markets. Frankly, it impacts whether you can or should go public, or whether you can or should sell to either a strategic or to private equity or someone else. All those things will be impacted.
Larry Grafstein:
And, of course, despite the adversarial tone of presidential election years, there's clearly an incentive to try to make the economy, on the part of economic policy makers, as stable as possible, those who are in charge now.
Vito Sperduto:
John, I think the other piece I think about is after you've had periods of disruption, how long does that take in different markets to recover?
And so we've all been through a number of those time periods historically, and if you look at obviously the volumes we saw in both of our markets in '21 and in the latter half of '20, post everybody getting comfortable with the environment, those were significant numbers relative to what we've seen in '22 and so far in '23 and where we think '23 is going to end up. It's difficult to think that you would go into a third year of that, given what we're seeing, given the quality that's sitting on the sidelines. It's such a large amount of dollars, whether you're looking at private equity funds, venture capital funds, private credit, you're looking at the institutional investors. It does feel that there's a demand in both directions, to make something happen. And so we'll be curious to watch what the catalyst is there.
John Kolz:
That's right. That's probably the question all of us get asked the most, which is what are the guideposts? What are the things we're looking for? We're never going to signal an all clear, let's go, forget about everything, but what are we looking for?
And I think you're right that I'm a simple person in some ways think that the dollars, where do they sit and what are their alternatives are the single biggest driving force.
We've talked about private equity, dry powder. We've talked about the relative attractiveness of the equity versus fixed income or other places for your dollars and just the dearth of product that has been out there.
I think one element as well that will be important for both of our markets is that, and we hit on this a little bit earlier, that the companies that are likely to be in both of our markets and trying to evaluate their alternatives are just bigger and better capitalized and more profitable than they were in other cycles. And I think that gets to it's just a higher quality company.
And that comes with, of course, maybe there's still a reckoning in terms of price. Maybe we haven't quite found that price equilibrium, but I do think it will, when it does reopen in earnest, we're going to have a higher quality calendar that will help ensure that the market not only reopens, but stays open and performs well.
Vito Sperduto:
Well, John, I know Larry and I have enjoyed talking about the current macro environment and some of the conditions that we're seeing impacting our clients, our mutual clients, in fact, who are considering what alternatives they have in front of them. And we look forward to talking in our next episode of the Forward Outlook. So thank you for joining us today.
John Kolz:
Thank you for having me. Very much enjoyed it.
Vito Sperduto:
Larry, thank you.
Larry Grafstein:
Great to be here.