Graham Tufts
Hello and welcome to Strategic Alternatives, the RBC Capital Markets podcast, where we uncover new ways to raise capital, drive growth and create value in an ever changing world. I'm Graham Tufts, global co-head of the Financial Sponsors Group joining me today. I'm my global co-heads Ram Amarnath and Harold Varah. We'll be discussing the outlook for financial sponsors in 2025 Harold, Ram, welcome back to the podcast.
Harold Varah
It's a pleasure to be here.
Ram Amarnath
Always good to chat with you guys.
Harold Varah
It's always good to get together, and we do this all the time, so it's kind of neat to do it for our friends, colleagues and clients.
Graham Tufts
Well, look, we've seen the stats and numbers in the activity for last year. We don't want to turn this into a full predictions podcast. Why don't we share some views here on deal making, environment, what's important to us, what's going to be important to our clients, and how we think 2025 is going to unfold?
Harold Varah
Yeah, I think that that makes sense, Graham, and I agree with you. Let's start in the deal making environment. Everyone cares about deals. Everyone wants to read about deals. And certainly, it felt like we had a really busy summer, didn't we? Last year, we got very, very excited about that. It seemed like there was this wave and rush before the election, and it was a little bit of an inflection point. And some really high quality transactions that we did, and I think it set the stage for this year. The election probably caused a little bit of a blip in terms of activity. People want to see how that got adjudicated, result. And then, of course, you know, people have been feeling pretty euphoric, from a market’s perspective, as we come into the new year. There's always a lag effect, you know, again, I think that second half really was encouraging. Deal volumes count, we're certainly up, you know, North of 20% versus ‘23 but ‘23 wasn't exactly a banner year.
Ram Amarnath
Yeah, look, it's a great point. And some of the issues that we were chatting about a few years ago, that was stalling deal activity aren't here, right? We probably couldn't have a better credit backdrop, you know, the L part of our, you know, LBO world is pretty good. In fact, that world, if Jon Cokinos was here, he would tell you they can't get enough product, right? So we know the leverage there will be there. I think the issue, it's really to deals. And, you know, we have some clients want to do deals. And I think the biggest issue right now is, there's still a disconnect on in private assets in terms of valuations.
Harold Varah
I completely agree, and I think, I think we're gonna have a theme, right, Graham, throughout this on quality, right? The deals that traded at kind of pretty high multiples in 2021 some of ‘22 that haven't necessarily gone and grown into those multiples. So I kind of feel like you're absolutely spot on. Ram, I think the demand is there. The question is, what type of supply is there?
Graham Tufts
Yeah no, totally, it was a different rate environment back in 2021 to where it is today. And so undoubtedly, the demand side is there. The supply side is not. Businesses are growing back into those multiples. It's going to take some time, which is why I think the first half that this year is going to start steadily, not a rapid bounce back, and we'll see a build through the year on a busier H2 than H1, I fear.
Harold Varah
I guess we're playing the prediction game, we can't help ourselves. But last year, last year, last year, even with the bounce back in in volumes in this summer, sponsors accounted for 30% of the overall M&A market, I'll go on record and say we should be back to like those 40% norms this year because I think you're spot on, Graham. I think that I think the sponsor activity, whether it's through, continue to help carve corporates with their carve outs, take privates…
Ram Amarnath
I think that’s a big one. I think you see a lot more of those.
Harold Varah
I think we'll be busy across the board. And so I'll go with that prediction and, we'll get to kind of liquidity and some of the growth in other asset classes, later on. Well, why don't we, to your point about exits stalling, let's talk about IPOs. I think, to kind of get to a more functioning deal making environment, you need to see the IPO exit alternative as viable because it's just so important for sponsors to have that as an option, especially for their larger assets, and I think that hasn't been available. And so I think we've all been trying to will that back to life. And quite frankly, looking at, kind of some of the higher quality names that are in our clients’ portfolios, looking at where the equity markets are, and just exceptional multiples almost across sectors, I think we should fall in line with everyone else, and say 2025 should be a constructive year for the IPO markets. Do you agree, Ram?
Ram Amarnath
I do—I think for the largest and best assets both because I think there isn't another option, as you said, and quite frankly, that might be palatable some investors, which is interesting, right? The markets are so high, so you would think, ‘Oh, therefore, why aren't the primary markets doing well?’ And as we all know, active managers are becoming fewer and fewer and, active managers would drive IPOs, not the passive managers that are out there. So we're gonna have to find the right alpha for active managers. And our clients are gonna have to play the patient game of being in their assets for what, three to five years…
Harold Varah
The sponsor backed IPOs that actually managed to happen in ‘24 had a median gain of 21% so you can say, ‘Hey, the asset classes worked,’ although, the S&P was up comparably, so maybe it was just in line, but regardless, it actually worked. I don't know, Graham, how you think about that with a European angle, if that's different?
Graham Tufts
I think from a size perspective, you’re spot on, the deals is going to have to be the larger deal. Deals can create real liquidity out of the box. I think the challenge here in Europe is the process that you have to go through. It's not the preferred exit strategy for most sponsors. You know, they like to have it, as you said, as a backup to processes. But the other thing we have at the moment is a differential in just multiples between the US, Canada and Europe right now, where we're lagging behind across virtually all sectors.
Ram Amarnath
That's a good point. I'll add one thing, and because with the thematic of larger IPOs, I think there will be a return in the U.S. I think it's going to be a lot slower in Canada, for the reason, there aren't that many very large companies that are ready to go public. And if you are a medium sized company, which is typical, as we would define medium, you know, in the U.S, would be larger in Canada. And if you're private equity backed, you probably have a private capital solution to sell…So I think the refunctioning of that market, I think will take more time.
Harold Varah
Last year we saw tech IPOs be around 25-30% it was as high, almost half of all the sponsor back IPOs in 2021 which is obviously the peak year. I actually think that the distribution across sectors is going to resemble a lot of what we saw last year, again, albeit with a smaller sample size, but I do expect, and again, because I think we're talking about quality, we're talking about size, I think you're going to see more healthcare names, you're going to see more industrial names. You're going to see more consumer names, and some higher quality services businesses. I think it's going to be more well-rounded. It will not be as heavy as a tech as we've seen. I think it's a little bit of what you just said. Of course, we'll see tech. It will probably still be the number one sector. When we're all said and done in terms of public exits from a through from sponsor backed, but I think we will see more balance. And quite frankly, I love that, because if you're talking about the IPO market, we can't be talking about just a bounce. You don't want to get like, ‘Hey, it came back and then, ‘Oh boy, it went away.’ Because look what happened. You don't want a repeat of ’21. And I think a more balanced end market mix of IPOs could lead into a more sustainable recovery of the public markets. I think what we're going to see is a minimum of $5 billion US equity values. I think that's enterprise could translate into this call it $70 billion I think that's where the focus is going to be, to make sure you have that liquidity, make sure that that sponsor overhang won't be impacting the potential for a rising share price and therefore, you know more regular way follow-ons. And therefore I think again, prediction, but where we're certainly spending time with clients is in sectors where private equity has poured capital in the last three, four years. Look for consolidation within those sectors, between and among sponsors, who will see shareholder value creation in that combination, not just through the traditional synergies, top line and bottom line, but because that scale will allow them to re underwrite an IPO exit. And I think that's the key, and that's where we're spending time with clients saying, Why aren't you thinking about this potential combination, because that's the path to glory.
Graham Tufts
As an add on to that, I'd probably also say a lot more cross border activity because of where rates are today, FX rates. You look at the multiple different differentials between the markets, there's gonna be a lot more cross border acquisition activity, particularly U.S. into Europe.
Harold Varah
I hope so. We're set up that way, obviously, to benefit from that, whether it's cross border U.S.-Canada or Europe. So I hope you're right, and I and I think there's a lot of signs that are pointing to that. So let's move on fundraising, because our clients obviously live and breathe it. So ‘24 was obviously a tough year. It feels like the market has been much more constructive. It feels like some of those really slow going on, some of the fundraise kind of accelerated as the year went on last year. And I've certainly had conversations with clients that have said, ‘Hey, we have our final close in April. We have our final close in May.’ I'm starting to have those conversations where, at least anecdotally, it feels like there was an inflection point, and there's been some acceleration in closings or to be closed…
Ram Amarnath
I think that's right, and I think that plays into the segue for winners and losers. But going back to LPs, I think some of the issues that they had in being able to put money to work is starting to normalize for a bunch of reasons, in terms of resetting of their weightings and getting some money back and being able to put money to work. So I agree with that. And if there's one thing that we called, I think, right for sure last time is this is what we predicted last time. We said the big guys are going to get bigger and the non-specialist mid-market folks are going to have it a lot tougher, and unfortunately, because a lot of them are clients and friends, it's been a struggle.
Harold Varah
I do think that that last point is really salient. And I don't know, Graham, if you've seen the same thing in Europe, but the quote, unquote mid-market firms, I guess that size could be that three to $7 billion fund size on the traditional private equity that were generalists, so cross industries, it's been very challenging for many of them, unless their returns were just top quartile, top decile. And so I think what we've seen from a behavioral perspective is that LPS still want to deploy into the mid-market. It's critical to their overall asset allocation, but they're looking to do it on a specialist basis. And so we've seen, and it's been difficult for a lot of these firms, but they've had to go through this transition to be responsive to their investors. And I do think that the winners coming out of this will be more mid-market specialists, and then the mega funds are becoming more mega and then I think what you'll see is those specialist firms will say, ‘Okay, we've heard you, loud and clear, investors, LPs in terms of what you want from us, but you know what? Then support us to do a maybe lower mid-market fund or strategy along the same vertical lines, if you if you like us in the mid-market, like us in the lower mid-market.’ And so what you'll see is, on a vertical basis, than being able to raise more capital, but still keeping in line with that specialist philosophy.
Graham Tufts
I think that's also true for some of the large cap firms, because we're now seeing, certainly here, a number of those firms raising mid-market funds to invest alongside the large cap funds. So we've got big teams here and finding enough or a number of large cap opportunities is really challenging, and winning those and investing your fund is really challenging. So one or two of them are now opening up mid-market funds as well to keep the teams busy. So, you know, it's an interesting dynamic that we have at the moment, because I think you'll see some of those large cap funds also trade down into that mid-market space. It's going to become quite crowded and more competitive.
Ram Amarnath
I think you're right; I think we will continue to see as a result of all this more consolidation among various GPS. And this is, again, to your point earlier, Harold, under the private capital banner, where it's going to be cross strategies, etc., and we've already been seeing some of that…
Harold Varah
And I think in private capital, we've seen actually really substantial overall growth, not only over the last decade of 14% which is 200 basis points in excess of just traditional private equity, but then if you look from 2020 where again, you could start to see some of the problems, starting around the private equity fundraising, private capital overall, was up 16% so how is it then the last few years, it's been up higher than the last decade, And I think it's because of exactly where you're heading, Ram. Because private capital strategies, such as private credit, hybrid capital, infrastructure, secondaries, these asset classes, I think exploded is actually a quite proper term. I mean, they've absolutely exploded, especially since 2020, 2021, 2022 and that's kind of led to a tremendous, growth in AUM. But more importantly, what I want to talk about is, how does that change our business? As investment bankers running one of the largest sponsors coverage groups on the street. How do we think about our client base? What products and services are we actually focused on? Because I actually think that our business is evolving in very exciting ways, and I think it's actually going to lead us to have to be much more broad based in our approach to our clients. The buying and selling of assets game. That's just a piece of what we're going to have to do to kind of solve our clients puzzle. Because this AUM growth has been so dramatic, a lot of it's been very low cost for insurance companies and our clients need to deploy it. And they're going to be looking to us, and they have been looking to us to help them. It's really exciting stuff as we transition from private equity coverage to private capital coverage, if you will, sitting in our seats.
Ram Amarnath
That's where our clients are going, and that's where we've been going. And I think we could all say with some of our clients, that's how we cover them today, and we're gonna have to continue to adapt and exactly what you said, help them originate ideas, irrespective of kind of the asset class.
Graham Tufts
They're not just looking for leveraged assets anymore, or leverage investment opportunities. They're moving into the corporate and investment grade space as well. They're looking for us, as their coverage guys, to try and find other avenues for them to invest, and almost be an origination engine for them for some of those asset classes that they're looking to invest in.
Harold Varah
That's 100% right? I mean, I think a couple years ago, when we were talking about Ram, it was a couple has been talking about private credit, yeah, we were talking about more in the context of direct lending, right? What Graham, what you're getting at is the kind of transition and the growth from just direct lending as a strategy to asset based finance, infrastructure based finance, commercial real estate based finance, structured kind of equity, if you will, into high grade corporates, to solve their problems, be a capital solution provider. And the AUM growth has been so dramatic, quite frankly, they had to do this, even it's good business quite, and they should be doing it. It's obviously up the credit spectrum, but they don't have enough, there's not enough supply of potential direct lending opportunities to satisfy their growth.
Ram Amarnath
There's a supply demand imbalance, and I think it makes our jobs, I think you guys would agree, even more exciting. So I think, to your point, Graham, the origination part of our job, which I think is the most important part, is only ever expanding.
Harold Varah
By the same token, I think other strategies have really taken off as well, right? So like infrastructure, which is just such a big core part of our business, I just mentioned the context of private capital, private credit, but it's certainly just the infrastructure investing funds, which used to be maybe a subset or an arm, is now really just taken off as its own strategy over the last few years. The heavy, the hard assets, have just been more resilient as we've kind of had different cycles. And I think that investors are really looking for uncorrelated returns and stable, cash flowing businesses to complement some of their perceived higher risk investments. And I think that the infrastructure deal environment has actually been much more stable these last few years, when we've seen like, again, more traditional private equity deal volumes down almost half from kind of peak levels. The infrastructure investing environments kind of stayed normalized, and the deals have become bigger and bigger, because we're dealing with asset classes that are enormous. If you think about some of the hard asset classes that you know, you know, power, energy, you know, transportation, these are just huge parts of our economy.
Ram Amarnath
Data. The pipes that infrastructure is now solving for is, you know, is data and fiber and communications, right? And the civilization of our economy?
Harold Varah
Yeah, absolutely, they're at the intersection of it…
Graham Tufts
That whole coms infrastructure space has grown enormously over the past two, three years. Absolutely, enormously. Partly on the back of AI, just the whole data consumption piece has just changed considerably. And the other thing, and I guess you guys will be seeing this too, is the advent of impact in ESG focused funds that are investing in to the energy transition space, but also all the all the associated businesses, services and suppliers to those sectors as well.
Harold Varah
Why don't we talk a little bit about some regional aspects, and this is kind of where we can kind of have fun. We'll try not to be too political. Even though politics seems to blend into everything that we do these days, it's kind of hard to avoid it. But you know, Ram…
Harold Varah
When does the leadership vacuum in Canada get resolved? In your opinion?
Ram Amarnath
It'll be sometime between May and October, depending on how things shake out. What's interesting… and look, we again, not the political but there's a lot of reasons why, and… this was well below before the tariff threats, there's been a greater disconnect between Canada and U.S. and economic performance than I think there has been in many, many years, for a host of reasons. But if you go back just a few years ago, I think the overnight rate in Canada and the Feds fund rate in the U.S. were on top of each other. Today, I think most economists are thinking there's going to be no more rate cuts in the U.S., and that's consensus, and maybe even a rate hike, you know, depending where things go in the U.S., I think our economist is thinking there'll be another five rate cuts in Canada. So there's a major differential in what you know, both the expectation for the economy and the required boost and where inflation is heading, etc. And lot of that has to do just with growth. You know, next year, our economist is thinking, before all of this, Canada will be at 1% and you know, the US is more than double that, which is a big difference, right? And, you know, the currency is, you've seen that dispersion, and that's already been reflected in that, I think we're kind of at what, 68, 69 cents today. I'll just say the last time we saw this, you know, where there's a lower growth environment, a major differential between Canada, the U.S. and the currency, kind of where it is. Sadly, as a proud Canadian, we saw a lot of hollowing effect of major corporations in Canada, right? It was an opportunistic time for global champions, especially U.S., to come in and look at opportunities, right? I think there's going to be a lot more transaction activity going forward, and a lot of that will be cross border, right?
Harold Varah
Because lot of these companies I was saying what you just said about the overall growth prospects are global businesses. They may be trading on the TSX or what have you, they may be operating with, with employees in Canada.
Ram Amarnath
Not surprisingly, a lot of Canadian businesses today are not doing a lot, and kind of seeing what's going to happen, but I think we'll likely see, as we do in environments like this, M&A increase.
Harold Varah
I guess the new the new the new administration, whoever that happens to be, could be either more friendly or less friendly, from a regulatory perspective.
Ram Amarnath
Yeah. I mean, the prediction will be more today, but we'll see where that goes. I think with our clients, I think we've already seen a lot of that, where, not just with local private equity firms, but global prime record firms, looking at Canada, and I think you're going to see more of that.
Harold Varah
Given our, market presence and within the Canadian market will obviously be at the intersection to help these companies, but also help our clients globally, to the extent there's opportunities, whether they're private equity or otherwise, to kind of, you know, I guess, take advantage of it, but hopefully, also, you know, potentially be again, that capital solution provider because it doesn't have to just be M&A, there's lots of ways that our client base, to our earlier conversation about the onset of private capital, can help these companies through whatever it is, whether it's balance sheet considerations, capex considerations, potential M&A that they need dry powder for, etc., like all these could be very interesting for us, just given where we sit and CAN in our present market, leading presence there to be able to help our clients globally.
Ram Amarnath
Yeah. Absolutely.
Graham Tufts
The European project is facing some economic challenges at the moment, and that's impacting growth. We're going to hopefully see continued and progressive rate cuts, both in the UK and Europe throughout this year. We need that. But if you think about it from an investor perspective, the dollar funds look really strong. I think that valuations here look comparatively weaker than in the U.S. I think that opens up a lot of opportunity for the cross border deals that we've been talking about on this podcast, and I think we'll see a lot of P2P activity here in Europe as well, because valuations aren't responding the way they have in the U.S., to the to the Trump administration, And it's, you know, it's, it's going to be tough here. And I think the other aspect here that we also need to take into account is China, because anything that impacts China, China is a big trading partner still of Europe, and that will have an impact here as well.
Harold Varah
Thank you, Graham. I really enjoy anytime we can get together and talk about our business, and I’m incredibly excited about how all these different trends we're talking about manifest themselves in the next few years, and hopefully we'll just be record setting years, not only for us, but also just delivering for clients like we've never done before. And so again, thank you. Ram, Graham… yeah, it's always, it's always an absolute.
Ram Amarnath
If there's a theme, there's never a dull moment. And it's, it's a lot of fun working with you guys. So thanks for the time. And this is always fun.
Harold Varah
You've been listening to Strategic Alternatives, the RBC Capital Markets podcast, and this episode was recorded on January 30, 2025. Listen subscribe to Strategic Alternatives on Apple podcasts, Spotify, or wherever you listen to your podcasts. And if you enjoyed this episode, please leave a review. There's a lot more that you can listen to, and hopefully we'll be back at you soon. But please, we also welcome any comments, any feedback, and look forward to engaging with all of you going forward.