Vito Sperduto
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 the RBC Capital Markets team, I'm your host, Vito Sperduto, Head of RBC Capital Markets U.S. and today I'm joined by a multi-time return guest, Joshua Rosenbaum. Josh is the Global Head of Industrials here at RBC Capital Markets, and this will be a very timely episode, because we're going to talk about the state of play across the Industrial space in general, which I think it'll be some interesting trends for everybody to consider, as well as some thoughts on the themes that we heard at our Global Industrials Conference, which was just held in Las Vegas last month, where we had a number of corporates and, you know, had some good dialog, and it'll be interesting to compare and contrast what we heard last year and what we heard this year from the companies. So why don't we get into it? Josh, welcome back to the podcast.
Josh Rosenbaum
Great to be back. Vito,
Vito Sperduto
When we spoke last year, Josh, I think the mood was starting to turn positive. The first half of 23 was fairly light in terms of volume. We saw a significant uptake in the second half of ‘23 and that's kind of flowed into ‘24 certainly. When we think about transaction volume, if you use M&A as an indicator. I think, you know, global M&A volumes are up 20% year to date. Right now, we look at US M&A volumes are up about 30 to 35% and a lot of that's just driven by a pretty easy comparison in the first half of the year. But certainly, as we, you know, think about our clients, what are some of the main factors that you were hearing from clients and kind of what's weighing on the industry these days?
Josh Rosenbaum
Well when you think back to roughly a year ago, when we last had a sit down post our annual industrials conference in terms of the state of the world, as I was reflecting on this, there's been significant progress. You know, at that time, we're talking September, October of 2023 you had a 10 year that was at 5%, you had very stubborn inflation, you kind of had a macro backdrop, the likes of which most people hadn't seen in their professional careers. We really didn't have a functional LBO market. IPOs were hypothetical at best. You know, in the event that things get better over the next 12 to 18 months, and you fast forward to today, and you know, no one's ready to sound the all clear today, but it does appear we're at the onset of an easing cycle, coupled with healthy employment numbers, which is usually the recipe for a really good backdrop. So today, you know, we have a vibrant M&A market. It's still more, I'd say, a corporate environment than a private equity environment, but private equity is increasingly active. We have a world where I'll speak for RBC specifically, we've actually done two great IPOs in the sector, both in Aerospace And Defense, lower and StandardAero. So that's a market difference from a year ago. And also just recently, I'm literally talking days, not weeks. We helped lead a financing for private equity firm Apollo, taking private public company Barnes Group. So while there are certainly challenges today, which we'll get into, I think just stepping back and reflecting it is indisputably significantly better today than it was a year ago.
Vito Sperduto
Yeah, no, Josh, I would agree. I think the tone and the sentiment from being in the meetings with a number of clients was a lot more about conversations around key strategic topics. I think they felt good about having their arms around their businesses and sort of how they were looking at that. Certainly we're sitting here today a little less than four weeks out, and at the time, you know, clients were certainly focused on that; the geopolitical instability is always impacting whether you have businesses in those areas or not. And, you know, look, I think they felt good about their businesses. I think they felt like they had their house in order, and it was allowing them to think strategically about options that they've considered in the past and some others. I think the one thing I would say is the transactions we're involved in today are generally transactions that have been going on for some time that make good strategic sense. I'm not seeing as much of people necessarily stepping out of their lanes, and maybe we'll see that change once we get through the next month or so, when people feel a bit more comfortable about the forward outlook and start thinking about that. I mean, I think that's generally been the tone.
Josh Rosenbaum
I think that's right. I think that's a fair distinction to make. I think it is a healthy M&A environment, a healthy M&A market, where corporates are still leading the way, but private equity is increasingly relevant. I think the caveat, it's a fair point that you make, is that public company M&A is generally being rewarded, but it has to be strategic and in the zone. You know, vast departures from the core, kind of experimental, new segments that you know, investors are a lot more discerning. And the flip side of this, and this totally is consistent with that, yes, there's a green light for M&A, but it should be in kind of your power lanes, is that, you know, we're seeing from large, diversified companies a continued trend towards portfolio simplification. You know, I'll give you some examples. Carrier streamlined its portfolio with fire and security and commercial refrigeration. Honeywell just announced the spin of their advanced materials business. Johnson Controls earlier this year, sold off two parts of their HVAC related segment. DuPont spins earlier this year. So absolutely. It's M&A, but investors want people to focus on those areas that they should be focused on. And the kind of the segue I have here, and we'll talk about private equity a little bit, is this is creating opportunity for private equity, for some of these corporate divestitures, where there isn't a natural other corporate buyer or potentially antitrust considerations enter the fray. So when we're seeing quality corporate divestitures, we're seeing a ton of private equity appetite and naming another name just we saw this most recently, just a few weeks ago, with the Carrier fire and security assets, where there was a very strong private equity bid, and private equity prevailed.
Vito Sperduto
Josh it's interesting to see a number of these Industrial conglomerates now going the route of streamlining their portfolios, where, if you go back 10-20, years ago, they were adding to their portfolios. And so it's an interesting sequence of events, especially as you've got new management teams, taking a look at that portfolio. But maybe before we get into some of the private equity side, we certainly on September 19, the Fed started a rate cutting cycle with a dramatic 50 basis point cut, I think, as we talked about with Lori Calvasina, our U.S. equity market strategist at the Industrials Conference, historically, when the Fed has started a rate cutting cycle like this, a year out, we've seen generally a positive performance from an equity market perspective. There's been a good surge in valuations. And so I think we're going into a cycle that is going to be positive for our clients, maybe as we think about some of the resilience that's been shown. And I know a sector you're close to, on the Construction side. You know, high mortgage rates notwithstanding, with this rate cutting cycle underway, you know, how do you think about that sector as an example, or other sectors that are impacted by some of these macro trends?
Josh Rosenbaum
Yeah, a large swath of industrials, and more broadly, all sectors are tied to interest rates. They’re definitely more interest rate sensitive sectors. Anything tied to housing, you know, clearly, people look at interest rates very closely. But you know, in the spirit of dramatic progress, we are almost indisputably entering an easing cycle, notwithstanding the hotter than expected September jobs report, which pushed the tenure up a little bit, but I think there's definitely a bias towards easing versus tightening, that would be a dramatic reversal. Combined with, you know, healthy employment rates. In theory, this is nirvana for the housing sector and construction related sectors. This is what people have been waiting for years. So it's a really good backdrop. It's shown in the public equity markets, where, you know, multiples are looking ahead. It's shown in the debt yields for some of these names. The flip side of this is that it takes a while for these interest rates, for lower interest rates, to kind of trickle their way into the broader economy and show up at financial results. So, you know, the Fed could start easing. But like I said, you know, the 10-year has remained stubbornly high. You know, mortgage rates are still north of 6% so this needs months, quarters, to get into the economy before people are going to see it in increased volumes. But the setup is there, the backdrop is there, which is why the equity markets, which obviously look forward, you know, are valuing it. And I think, you know, coming back to M&A and the M&A environment, I think the management teams, the board members, the people that have been in industry for a long time, recognize this favorable backdrop setup. So yeah, people in the construction related sectors are very excited. This is what they've been waiting for.
Vito Sperduto
And maybe Josh, what did you hear from some of the other clients in other sub verticals that stood out to you? Any notable developments?
Josh Rosenbaum
Generally, there are green shoots within Industrials, given that there's so many different businesses and so many different drivers. Today, I think I'll start maybe with kind of shared challenges. In large areas there's been destocking. We've had high, interest rates, which do mute spending for various you know, capital goods also affect the consumer. So all things, things will affect most of the industrial sector, but within that, we're seeing really strong activity out of Aerospace and Defense. It’s one of our strongest franchises in at RBC. We've been incredibly active there. I think it stands to reason for everyone here, pretty intuitive that defense is strong, especially in the tech area, cybersecurity is kind of an ancillary business there. The aftermarket for commercial aerospace has also been strong after pent up demand from the pandemic. And I think, you know, probably the best thing I could say is, we've been doing a lot of M&A, there's been a lot of public company M&A, there's been private equity interest in the area. But as I, as I said before, it's actually where the most active pocket for IPO activity, we've had two very successful IPOs in this space, as I mentioned before… So to me, that says a lot of better Aerospace and Defense. Industrial services, generally critical services related to infrastructure and the grid and other needs that businesses and people have, regardless of the macro economy, they tend to be pretty resilient, all weather businesses, so there's always demand for those. They also tend to be scalable to the extent their route based. So private equity likes that space. There's also several large caps in that area, you know the Waste Management's Republic, GFL and so forth. So there's been strong activity in services, I'd say even more so when the services, in addition to critical needs and ideally recurring revenue, subscription based models, if they touch upon secular themes related to sustainability, energy efficiency, water infrastructure, technology even more so. And the valuations show that both the transaction valuations as well as the public comps. The last area, and it's a little bit of a catch all, you know, we tend to call diversified industrials, which itself is incredibly diverse. Some headwinds, some things related to, global supply chain. Some things certainly related to destocking and your higher rates, crimping spending expenditures a little bit. Where there are diversified capital goods businesses that play on data centers, water, electrification, technology infrastructure, there's clearly a lot of demand and a lot of interest, and we've seen that, you know, for the public corporates, as well as from private equity. And I combined that with, you know, building and construction, which, if this easing cycle holds, combined with strong employment rates. It's a really nice backdrop there as well.
Vito Sperduto
We mentioned it earlier. Why don't we get into the private equity topic? We certainly are seeing probably the highest level of service in terms of number and value of portfolio companies sitting in private equity portfolios. They're staying in there longer than they have historically. We talked about it last year, there being a pent up demand for deals, both in terms of new transactions and in terms of exiting from existing deals. And that's continued to be the theme, I would say, if I look at it, you know, there was an abnormal amount of private equity exit activity from the second half of ‘20 into all of ‘21 those 18 months were the most we've seen in a long period in history, I believe. And I would say the exit activity has been slower. We've seen some decent activity in terms of new entries. And so there's starting to be somewhat of a constructive LBO market, although I would say we've seen green shoots, and we've been participants in it, but it's also early days. But, you know, give me some perspective of what you're hearing from the private equity clients, both in terms of newer transactions that they're looking at, but also in terms of how they're considering transactions on the exit side. And I think, you know, Josh, you and I have always said, like, once we get to a constructive market from a financing perspective, we're going back to regular way. LBOs versus continuation funds or minority sales or the like that are going on a bit more these days.
Josh Rosenbaum
I'd say, going back to the beginning, when you take stock of today versus a year ago, a year ago, there really wasn't a functioning, regular way LBO market today, there most definitely is. As I said, you know, just in the past few days, we announced the take private of Barnes Group for Apollo, which is required, you know, regular way, traditional LBO financing. We've also done LBO financings. This is just in the past few weeks, for nVent and for Arch Key. This is RBC, you know, leading the way with underwritten LBO financing. This was not the case last year. Last year, you were looking at structured transactions, 50/ 50 existing owners rolling their equity to keep the capital structure in place. So it's a huge, huge difference from last year. However, we are not nowhere near where we were in 2020, 2021, where it was. I mean, it was, it was a feeding frenzy. And private equity right now is being more discerning. You know, these are broad statements, but, you know, it's difficult to get perfect data on this. But I think if you did, it would definitely bear this out. I think, right now, definitely a preference for take privates, corporate divestitures. I also mentioned corporate divestitures versus private equity to private equity, sponsor or sponsor deals. Now, that's not to say that they're not going to do sponsor to sponsor deals, but it just seems like the bar is higher. So there is a functioning LBO market. There is private equity appetite, but it remains discerning. And the other thing I have to say is that while there is a regular way LBO financing market, it is not back to what it was in 2020 and ‘21 in terms of the quantum of debt and the cost of debt. Obviously, base rates are still now much higher than they were back then.
Vito Sperduto
We all see a constructive market forming, and, hope that it continues to progress. I think it's definitely accelerating at a slower pace than we would have anticipated, but that's to be understood right now. And I think, you know, there's all the conditions exist and look like they're going to exist going into ‘25 for a continued strong market there. I mean, the other piece we always talk about Josh is just trying to make sure that even large private equity assets have multiple alternatives, and one of them that you mentioned earlier that it's been great to see that market revive the bid is on the IPO side. And, you know, we take a look at, you know, like StandardAero out of Carlisle's portfolio, having, you know, what I would call a very successful IPO so far, you know, certainly upsides from a billion to 1.4 you know, priced at 24 bucks a share, currently trading above 32 per share. I think there was a an appetite out there for a strong industrial business like this, especially in aerospace and defense. Maybe give me some thoughts on the IPO market and how you're seeing it as a true alternative for some of our clients that are thinking about monetizations.
Josh Rosenbaum
Yeah. Well, no, first off, like I said, it is not, you know, the all clear on the IPO market for most of industrials, aerospace and defense has been a shining star, though. The rest of industrial. It's been more muted. There is a real backlog forming, and I think the setup and the backdrop is getting there. And I think we are going to see much more broader participation in the industrials IPO market heading into ‘25 which is great. And by the way, this also dovetails to our conversation on private equity, because if there's a more muted or higher threshold for private equity to exit via sale to private equity, if you have a high quality asset that there may not be a natural strategic buyer for, the IPO is incredibly viable and incredibly attractive exit option. So I think there are going to be a lot of private equity firms that are going to look to this IPO market. I'm very focused on this. There's a lot of assets lined up. And, you know, like the IPO markets, like, you know, vast segments of the financial markets. You know, once one person goes kind of clears the way. So this is exciting. We haven't yet reached that inflection point, but it is a dramatic difference versus a year ago, where you mentioned these AMD, IPOs. So as we look at the 2025 I think the, you know, for industrials, IPOs, we're hoping that's the next inflection point, broader participation there.
Vito Sperduto
Yeah, it's a clear sign that there's, you know, there are certainly funds on the sidelines with money to put to work looking for opportunities and I think businesses like, like StandardAero and others that are making it out there right now are getting rewarded at being at the front end of it, which is good to see. Josh and just kind of finishing up the conversation here. You know, we're not in the business of predicting what's going to happen in, you know, the forward markets, let alone an election that's coming up in a little less than four weeks. But you know, you and I and others are constantly getting questions from clients about how to prepare themselves, depending on which party is in control, and sort of what their what their primary objectives are. But maybe, as you talk to clients, what are some of the elements that dominate the conversation. Are you seeing people take a pause until we have clarity, or are you seeing them move ahead? I mean, we talked a little earlier about, you know, we've got a number of situations where clients are pursuing strategic transactions that they've been looking at for a while, and they're not pausing to wait, to wait for the election results.
Josh Rosenbaum
I think in terms of rates and inflation, people are directionally getting comfort with where we're going. So I'm not saying that's completely off the table, but there's confidence management teams in the field board level that we know where that's going. They're actually knowing always that there could be two steps forward, one step back. In terms of the election, which is less than a month away. I think people are taking, I think first of all, for highly strategic M&A, the kinds of things that corporates want to own forever, that you know they're forging ahead. I think there are tactical considerations related to volatility, if you're dealing with public equity or public debt, where you do want to manage around the election you know, either before or after it. But for the most part, this core, highly strategic M&A, you know that just goes on, but you manage your timelines accordingly, the election is highlighted in every deal timeline, but regards the election itself. What are people focused on? The antitrust environment, for sure, and to the extent that the election outcome could change that favorably or keep the status quo. I think people have their eyes on that. You know, where does that come into play on a practical level, if there is a deal where there are antitrust considerations, you know, maybe you are waiting to see what happens after the election. I think the other related ones, which are specific to various sectors are with regards to tariffs, depending on how the election goes. What if any tariffs are put in place, how deep and broad they go. And for certain areas of industrials, that's a big deal. The other thing is tax rates. As you get into certain pockets, there are specific regulatory considerations that the election outcome, both federally and some local elections, can have an impact on. So it's a real thing. But I think, like, as you noted in your setup. If you long term, have a coveted asset, a must have asset, the outcome of the election is probably not going to sway you, but it is a tactical consideration around timeline. I think that the appetite for management and boards to do large deals now closer to the core, I think still kind of the new adjacencies and more experimental growth platforms, TBD, but larger deals in strategically important areas. I feel like the appetite is as strong as I've seen, certainly in the past 15 years. And I was reflecting on this because it's a little bit of a change in sentiment from defense maybe in the 2000 and 10s to offense today. But that long, dark shadow of the global financial crisis, the GFC, you know, going back 2008, 2009, I think that was a real shadow that was cast over boards and management teams when they were looking at M&A, and I think there was a little bit more of a defensive mindset. And here we are, about 15 years later. And I think that shadow, I won't say it's completely gone, but it's a lot it's a lot narrower, it's a lot paler. And part of this is just, you could go look at the management teams and boards, and you could see that a lot of the people that were in those seats, you know, eight or nine, and they're gone. And this is just the human element, that if the people have turned over, there's been a transition. New people come in, new mindset. And by the way, no one is saying people should forget what happened during the GFC. I mean, obviously you have to manage risk accordingly, but I think it is a little bit of a different mindset in industrials, which I think bodes well for increased and larger M&A activity.
Vito Sperduto
Yeah. And I, Josh, I agree with you on that sentiment. I mean, that's an excellent point. I think, if I were to think about it in general, and we've looked at a lot of these statistics historically, if you look at cash on balance sheets, looking at the S&P500 companies as an indicator, and you look at it at the at the end of the GFC, sort of the end of ‘08 timeframe to now it's over 2x when you look at it. And even if you take out, sort of the buildup in cash on technology balance sheets, which is usually where the biggest ones are, it's still on a per head basis, is significant. And so I think you know, you're right. Boards and C-suites found themselves getting a little too close to the edge during the global financial crisis. They probably, you know, as the pendulum always goes, kind of overdid it in terms of building up cash and getting themselves ready. The other thing that's happened, Josh, I think that I'd add to your points is that during covid in sort of the 2020, ‘21 timeframe, and then just the year or two, you know, after that, we definitely saw companies take care of their own house in a bigger fashion, whether it was determined which assets they were going to keep, what they were going to divest, but they also made sure that they took advantage of the lower financing rates that were available to them to properly set themselves up going forward. And so we're going to see a bunch of that refinancing happening in the Debt Capital Markets in the coming years, just in terms of some of the Covid financings, but at the same time, they're sitting in a much better position from a leveraged perspective, cash on balance sheets. And so now it becomes a capital allocation question. I think there's a there's an opportunity here, and especially, you know, you look at the boards, and in many cases now, the C Suites have been in there for a period of time. They own these companies, and they're trying to think about, what do I do next? And I think, you know, the comfort of adding in their lane is important. Now, you made the point as we think about the election that's coming up. I do think if we're looking at folks that are considering something larger and more strategic like that, they'd like to understand where regulatory policy is going on a go forward basis, to get greater comfort. But also, look, we've talked about it, and we've maintained a dialog with the different agencies on that topic. Their focus is on the larger platforms. Their focus is on the larger conglomerates. I think there's good strategic transactions are getting done, and certainly they're getting a more extensive review, but they're getting through those processes, and we are helping a lot of clients manage those. Josh, I've really enjoyed the conversation. I think we've got an interesting time frame ahead of us. I'm pretty excited about what's ahead in the next 12-18, 24, months, because it feels like there's a good level of activity to be had across your sector and others. So thank you for the conversation and look forward to having you back.
Josh Rosenbaum
Great. Thanks. Vito, yeah, and hopefully we do this again in a year, and there'll be continued progress exactly,
Vito Sperduto
You have been listening to Strategic Alternatives, the RBC podcast. This episode was recorded on October 9, 2024. Listen and subscribe to Strategic Alternatives on Apple Podcasts, Spotify, or wherever you listen to your podcast. If you enjoyed the podcast, please leave us a review and share the podcast with others.