Nitin Babbar
Hello and welcome to Strategic Alternatives where we uncover new ways to raise capital, drive growth, and create value in an ever-changing world. With insights and outlooks from RBC Capital Markets team, I'm Nittin Babar Global Co-head of Equity Capital Markets, joined by my counterpart John Kolz.
John Kolz
Nitin, it's a pleasure to be here and it's great to be looking forward into 2024 after a very interesting 23.
Nitin Babbar
Today John and I are excited to welcome Duncan Smith, Justin Grimmond, our European and Australian heads of equity capital markets to discuss trends that will shape our ECM markets outlook over the first half of the year. Duncan, Justin, glad to have you here. Let's get right into it. This time last year, one of our predictions for 2023, perhaps it was a hope more so than a prediction, is that we'd move away from the macro and into the micro talk more about the fundamentals of businesses rather than what's happening with rates, unemployment, CPI and other such measures. Unfortunately it didn't work out that way. What do you think the economic environment will look like in 2024, John?
John Kolz
One thing that I find fascinating is we have a sort of raging debate in terms of macro interest rate policy, et cetera, and notwithstanding all of that, we have markets that are largely quite encouraging for the opening of 2024 and we all know we've been doing this a long time that this is still a market that is very much one of human participation and of emotion and of confidence and of interest level and all that is a good sign for, and we're hearing this directly importantly from investors that they're very much engaged. Their engagement is as high as it's ever been in terms of interest level to see companies to rebalance portfolios to look for new ideas to put into their portfolios. We've got elections in the US, potentially in Europe and certainly in other parts of the world as well in the us The actual event in November is of course proceeded by the rhetoric that's already happening and then the primaries in the summer, we are going to be navigating that by definition in what will hopefully be a return to the new normal of issuance volumes. Our data, if that's a guidepost, would tell you that election years don't in and of themselves produce lower volumes of issuance. What they do though is make timing and navigating windows even more important than it already is, and so finding those opportunities to hit an open window is going to be crucially important as we navigate 2024.
Nitin Babbar
I have to agree that what we've seen late into 2023 is very encouraging. It's really unfortunate that it took a hard pull at the handbrake in October to drive us to a point where at the end of the year not only is the s and p up 20%, but we've got the 10 year US treasury down below 4% after peaking at five and a quarter. So to see that volatility was somewhat startling, but as we sit here today, regardless of our ability to walk away from the macro, I think we do set up quite well. I think central banks in hindsight will have taken action some more decisively than others. That sets us up for an environment or rates are going to be stable, higher but manageable, which means that investors are going to be able to focus on how they get returns. But behind all of that, if you want the micro, you got to live with the micro and that is you got to see earnings growth. That's what's going to drive the expansion of markets and that will be the burden to management teams to deliver on that growth to ensure that their margins continue to be very tight in an environment where we are not post high inflation perhaps, but just living with the tail end of high inflation to be able to generate the free cashflow and earnings that investors will want to see to put a bid in for their stocks. Justin, what about your region? What are you seeing there?
Justin Grimmond
Look all very consistent with yourselves. A much more stable and interest rate environment maybe a year later is definitely allowing ASX investors to do more fundamental analysis and focus on quality. The focus areas here are the same revenue, quality margins and competitive moats. I think companies that can maintain resilient EPS growth in a slowing economy are going to outperform. We expect the Australian economy to remain resilient. It's good for issuance and it's great for ECM activity.
Duncan Smith
The one thing I might add just on the macro and the dominance of the macro of last years, it's very understandable why that's been the case. We've been through a period of unprecedented low free money in essence, and we very quickly pivoted to a period of very fast and extensive rapid rate rises.
Nitin Babbar
It's a great point, but what's remarkable is that towards the end of 2023, the speed with which rates have come down again and the control that the Fed and other central banks seem to have taken on inflation is just remarkable.
Duncan Smith
Yeah, I think that's absolutely right and I don't think we're expecting the macro to fade away completely. However, it does feel like its domination is going to change over future months and through the course of 24 and as previously noted, that is going to be important for a pickup in ECM activity. One of the other trends linked to that is the increasing importance of passive investing within equity markets, which we know has not been part or cannot be part of the capital formation process certainly as it relates to IPOs and often not in the case of regular follow on or sell down activity. Clearly a very important part of the overall equity market ecosystem, there's no doubt about that, but this increasing focus on bottom up investing, again, super important for active investors, the passive investment community, more important for secondary market trading and activity further down the line, but again, micro bottom up stock picking is what's super important when it comes to IPO activity.
John Kolz
Well, as we all know, the IPO market is something that has been really absent from the discussion in the last couple of years and we remain optimistic for 2024. We see real signs that that is about to change and the signs that we see are a few fold, mostly from the investor side, which is going to guide a lot of the receptivity and the calendar for new IPOs. One interest level in testing the waters interest level in not only analysts but portfolio managers, seeing companies that are on the track to an IP has never been higher. We've had a real nice rally here in the US in particular in the end of the year, so overall participation levels, our expectation of those participation levels is quite good.
Nitin Babbar
One of the things that I'd point out, IPOs have never been the barometer of health for the Canadian marketplace. They are important. They happen far less frequently than the US where they are always the headlines, but in Canada was critical for the health of the capital formation process is some of these larger deals and we had the good fortune of leading that Enbridge transaction in September $4.6 billion where investors from all over the world came to support a company in large scale M&A. Those investors came from all of the geographies represented on this call here at today, and to me that's the stronger sign of the strength of markets. So we have seen resiliency. I do think that the IPO market will return. We see a pipeline ahead of us that has some high quality issuers and what's critical here is the quality is at a much higher bar than perhaps we would've seen in 2021.
Duncan Smith
One other thing I would just point out particularly is that whilst there hasn't been a great deal of IPO activity and that's a global comment as well as a European comment over the last couple of years, it doesn't mean that the techniques and the technology that we use as ECM practitioners is in any way broken, but there are a number of fine tuned items, certainly earlier. Investor engagement is something you've heard us talk about many times before that will continue to be a very important part of the process. Familiarizing investors with your investment case early on in the process such that when you do come to actually hit the go button on the IPO, there's already momentum in the transaction and in a similar vein, what we have seen through ‘23 is a mild increase in a number of transactions that hit the market with cornerstone or anchor investors already in place as they actually come to market. That's a natural reaction to slightly more difficult environment and by no means is the only answer in the panacea to making sure that an IPO is a success, but it's certainly a logical and helpful one in more difficult markets and can easily be applied as we go through ‘24 even as we expect backdrop and the overall environment to improve as we earlier said earlier.
Nitin Babbar
Yeah, one observation that I'd make is that on a go forward basis, the IPO market has to be one of relationship between sponsor owner of the business and the public markets. I think in 2021 we were probably more transactional than we should have been, but on a go forward basis, I think it should be strategic to go public, not just an opportunity for monetization, but strategic to grow the business, to have public currency and to of course create value for shareholders. Maybe we pivot now to discussion on the financial sponsors as we think about the rate environment and the macro and where we set up an equity capital markets here today. Perhaps you can share your thoughts, John, on how the financial sponsor community is looking at ECM activity.
John Kolz
I agree, Nitin, that they're going to be key to the equity capital markets calendar broadly both IPOs and follow-ons. On one hand, it's no great surprise to anyone that there is a significant amount of pent up supply that they have companies that are out there that they own, that they've grown, that are doing very well, that are waiting for a valuation and a receptivity that makes sense in the marketplace. On the other hand, it's also interesting that what the market wants right now, the market wants balance between growth and profitability and almost by definition in a lot of ways that's the type of companies that private equity own, they are in the business of owning profitable companies that they can add a little bit of leverage to and that they can grow either through either organically or through m and a and then having a balanced growth company come out into the IPO markets rather than maybe what the IPO market got too fixated on was hypergrowth.
Companies that were in the will turn profitable later, trust us, which the market has very much less interest in right now as we all know. So I'd also say that private equity as we'd all expect, is using every tool that they can to continue to be creative and to continue to try to fill in the blanks, if you will, between times when they access the markets, whether that's through the use of derivatives, whether that's through the use of margin loans, both with their public positions and with their private positions, whether it's in being more creative in how they monetize, for example, using call options in addition to selling stock outright. I think that level of creativity has also been useful to reopening things in the most constructive way. Justin, any comments on the sponsor side of things?
Justin Grimmond
I think in Australia we've definitely seen the IPO market shut for at least the last two years. I think we've only had 1 billion raised in 2023 and we kind of take back to the very busy year of 2021 where we had over 13 billion raced. I think with a slower IPO market over the last two years. We are definitely seeing a growing buildup of the PE owned IPO candidates here in Australia. A lot of these sponsors are going to be looking to exit over the next 12 to 18 months and we're having formal conversations around IPO, but probably more importantly around the dual track process here in Australia. Sponsors understand that when they're coming to market, one of the key increased scrutiny from in the investor community will be valuations. That is a key battleground that has been an impediment to IPOs here in the last couple of years. As we move more into the IPO market here in Australia, I think the complexities between the valuation gap and the dual track process is probably going to play out again.
Duncan Smith
As we know, UK equity markets have been relatively undervalued for a variety of reasons compared to their European peers or particularly their North American market peers and sponsors have spotted that value opportunity and been very much of that take private and M&A activity that we've seen a lot of through this year. But I guess the other point to make is they do own some super high quality, very material businesses around Europe that definitely fit the characterization that you've just been through. John, what I would call defensive growth, profitably growth established businesses that are really world leaders in their category of material scale, and those are the businesses that we feel are going to appeal very much to public market investors.
John Kolz
Well, and Duncan, interestingly, one of the things I know you and I have been talking about recently is where will those IPOs happen? Right? The sponsor community I think is very good at finding the right investors wherever they are in the world. We have seen them go to different listings, to dual listings to wherever the right investor base lives, irrespective of whether this is a European asset or a US asset.
Nitin Babbar
It seems that there's a universal truism about IPOs. One is that value has to work for both sides. I believe the rate environment that allows sponsors to optimize their capital structures, that trend seems to be improving towards the end of 2023 and depth in liquidity, and that's what draws many to the US market. But I think there are other markets where there are unique businesses that are more suitable to those economies, but from what I'm hearing from everybody on the phone here, we are optimistic that after this point of returning balance to the marketplace that buyers and sellers of IPOs should find a place to meet as we pivot from IPOs to broader equity capital markets activity, can you just talk about the themes that you think are going to be most relevant in the coming year? Maybe John, you want to kick it off?
John Kolz
Yeah. I think the key themes in the coming year are as follows. One, it's going to be balance. It's going to be yes, there is a real desire to have transactions find their way to the marketplace, but do it in a way that works for both sides as you said, and I think we can't overestimate that enough. I think it is a year of creativity and a theme we'll see that whether that manifests itself in being willing to consider other products alongside any of the transactions that they're doing, whether that's convertibles out in the marketplace, mandatories alongside of an IPO to bring a different investor base, whether that's the use of derivatives in monetization strategies or margin loans against positions to increase returns to the private equity sponsors. I think all of that creativity is going to be utilized in the marketplace, and I do think as well, it's going to be a real focus out there of having broad-based participation from the buy side in a way that changes the playbook from history.
Nitin Babbar
Duncan, how about you? What are you seeing in terms of 2024 themes?
Duncan Smith
Well, look, I like the word balance and I also like the word broad because I think both of those things are going to apply to what activity we see in the ECM landscape in Europe. We've seen over the course of ‘23 an increased usage of corporate equity derivatives alongside and in fact on their own coming into marketplaces to help facilitate monetization for owners of those businesses. And those have certainly been successful and certainly been very successful employed alongside regular plain vanilla strategies as well. So certainly think we'll probably see more of that as we go through ‘24. We've also seen the utilization of company to try and facilitate any sell downs just to try and mitigate the impact of a large block of stock coming into the market. Again, thoughtful solutions, coordinated solutions for owners of businesses that also suit shareholders alike, making sure that the impact of those transactions was minimized in the marketplace and digested well, and we've seen a lot of examples of success where that's been a win-win both for seller and buyer of particular transactions.
Coming back to the earlier point on balance, I do think if I look through the overall pipeline, what is really refreshing to see is a broad universe of companies and owners looking to access and starting to think about accessing equity capital market. It is not skewed by the distortion of free money interest rates, certainly as they moderate encourage breadth of businesses to come to market, and that doesn't just mean breadth in terms of sectors, it means breadth in terms of maturity of business. Yeah, absolutely. Equity markets love high growth businesses, but it also likes those mature businesses that have more stable growth and are very well established already in their own marketplaces.
Nitin Babbar
One of the things that you remind me to comment on is some of the execution and financing structures in the Canadian marketplace. There's been an evolution over the last number of years. I think there's been a greater recognition that US investors are very important and for that reason, management teams understand the need for speedy closings for using processes that global investors are familiar with shelf prospectuses. So we've seen some great improvement in terms of the regulatory framework that allows our Canadian companies to look a lot more like US and European companies that are able to engage with investors more openly, whether that be in the construct of funding or whether that be in the construct of m and a. Justin, do you want to add anything to that?
Justin Grimmond
Probably key themes that we're seeing and we've seen that develop pretty rapidly in the last three months. I think there's still going to be continued strong support here in Australia for that on strategy m and a and growth financings, I think we're going to see most of that activity in the resources space here in Australia, which we've seen a busy year. I think a second point worth mentioning for here in Australia is that the new economic environment that we're seeing is definitely seeing a lot of the investors here look to rebalance their portfolios and rebalance those portfolios pretty aggressively. So we've seen a really positive uplift in the block market, and I think we're also seeing the benefit of all those 2021 IPO escrows come to an end.
So our expectation is that if markets remain resilient, our block business, which has accounted for about 25% of issuance this year, more than doubled up, what we've seen in the last couple of years should be still pretty strong. I think a third point worth mentioning in Australia is that investor activism has definitely increased, and we've seen that with a very much a renewed focus on business strategy, on capital allocations and at times some ECM transactions. So public market investors here are just not accepting transactions for the sake of it. We're seeing these investors do a lot more work on the fundamentals of a deal, on a deal by deal basis, so very different to what we saw during the covid raising periods that investors in Australia are really prepared to do the work and are happy to stare it up to management teams and say no.
Nitin Babbar
2023 was a year of convertible activity that was different than what we had seen in prior years. Usually a growth oriented funding vehicle for technology companies and healthcare companies in the minds of many pivoted to a framework that was a cost of financing framework for large cap investment grade companies. John, your market had it all this year. What can you tell us about the convert market in ‘23 and what you expect in ‘24?
John Kolz
It's good timing for this pod. Little bit of a frame of reference this year we'll end up with about 50 billion US of convertible issuance that's up from, call it 25 billion in 22, which was a dismal year for issuance and maybe averages 40, 50 billion a year or so for the last 10 years. We think that the conditions are still quite ripe for a very good convertible year in 24, and you hit the nail on the head nit and it's both the potential return for what had been the predominant user of the convertible market growth capital for tech and healthcare, which frankly has been largely absent from the big uptick we had this year, but the conditions such that investment grade companies can refinance straight debt by using a convertible and still be cash on cash better off than they were, and to pull that off, of course, there's no free lunch.
You're selling a call option on your stock embedded in a convertible, but getting to a point where stock prices and valuations are such that that trade-off is worthwhile for many more issuers than had been in the past. And we see those dynamics continuing and sectors that historically were not big of convertibles we think will continue to be energy, power and utilities, financials, REITs even, and the addition of industrials and the historic biggest users. Tech and healthcare, again, all lines up to be in an interest rate environment where hopefully in the US will throughout the course of ‘24, if our economists are right, we'll be talking about rates that have stabilized and maybe are potentially heading back down, which can really be optimal for converged.
Nitin Babbar
Let's pivot now to sector themes and trends that we're seeing in our respective geographies, recognizing that there's going to be some similarity across the world here. Maybe Justin, we'll start with you as to what you're seeing in Australia as the themes and trends and sectors.
Justin Grimmond
Yeah, thanks, Nitin. I think in Australia, the gift that keeps on giving is our resources sector, and I may have mentioned before we saw about 30% of all issuance in Australia this year coming from that resources sector and in particular the critical mineral sector. I think just reflecting on this couple of stats, roughly one in every $3 of ASX ECM activity in 2023 was delisted mining companies. So that's up from around one in 10 from six years ago. So we continue to see this being driven by the copper and the critical minerals miners accessing supportive capital markets to fund new projects. We saw a really busy first half in the critical mineral space. I think always with the mining sector, the impact of China as a buyer is going to be a critical factor here for the mining space in 2024. I think a second theme probably worth mentioning for Australia is that after a tough 18 months for the tech sector, we're starting to see a lot of renewed interest, which is great to see given the fact we saw a really high activity during that covid period.
So it's a lot of focus on companies that are, I guess, well-placed to benefit from the AI here in Australia. This includes digital infrastructure and providers of software companies and we're seeing a lot of activity in the private space who surprisingly are considering or wanting to stay private, given the fact that getting a lot of access to capital here in Australia. But I do think that better interest rate outlook, as we've talked about for some time, is going to provide a boost for these tech stocks. I think finally worth mentioning here in Australia, we see it every year, and that's the elephant deal in m and a in infrastructure or some kind of large cap industrial. So I think we will see that again in 2024.
Nitin Babbar
You're absolutely right in the importance of energy to the Canadian marketplace, and I tried not to use the balance word again, but I'm afraid I'm going to have to, the investor environment has changed such that it's okay to be an energy producer because people understand that transition will take time, it'll take investment. We had a tough year for some of the renewables companies this year with cost of capital going to a point where the ability for people to believe that projects can be brought online on budget diminished quite considerably. And so the good news is as we end 2023, we have an improved dynamic where renewables and transition are incredibly important and well-recognized, but the path to getting there involves some of the traditional energy sources, and we've seen quite a bit of activity there. As I put on the crystal ball and look at what happens next year. Infrastructure just like Australia, infrastructure and resources will be an incredibly important part of our markets going forward, but the uses are changing dramatically as just an outline outlined, copper is being bid for battery tech, not only for building housing, and so that's a fantastic acknowledgement. We're seeing broader investor interest that goes beyond specialists to generalists and that's happening live and as we go forward. We also think that the rate sensitive sectors, utilities, the real estate space will have a recovery. Duncan, anything to add?
Duncan Smith
If you look across European pipeline and what are the sectors represented within it? I think consumer and parts of the consumer complex, well represented technology services, unsurprisingly and technology, very much part of that pipeline, but a breadth coming through from industrials, from healthcare, from financial services, so again, a healthy balance back to that word balance, a healthy balance of sectors represented in that pipeline in terms of structures. The one other thing worth highlighting is we've seen a number of carve-outs through the course of 23 with large corporations across Europe looking to refine their own equity story and their own business focus whilst giving a material subsidiary the opportunity to track its own path, and we do expect there's going to be more of that throughout Europe over the course of 24 and probably beyond. As businesses look to refine and refocus and re-energize certain parts of their business. That's certainly something we do expect to continue.
Vito Sperduto
You have been listening to Strategic Alternatives, the RBC podcast. This episode was recorded on December 14th, 2023. Listen and subscribe to Strategic Alternatives on Apple Podcasts, Spotify, or wherever you listen to your podcasts. If you enjoyed the podcast, please leave us a review and share the podcast with others. Thank you.
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