Vito (00:08):
Hello, and welcome to M&A inflection points, a podcast from RBC capital markets, where we explore the major issues impacting mergers and acquisitions today. I'm Vito SPTO co-head of global M&A and today I'm joined by Larry Stein, deputy chair of global investment banking.
Larry (00:26):
Great to be here, Vito. And I think it's an especially interesting time to discuss the M and a market just given the various factors that are affecting it today.
Vito (00:34):
Yeah. And look, I think we're always talking about kind of where we are in terms of M and a and just markets and economy in general. And it's been interesting to watch this year unfold. I think obviously there's been some shocks to the system between what we've seen over in Europe, from the Ukraine war perspective and the impacts that's had, and that economy deal flow and globally as well. The other pieces we always talk about are we, you know, out of the pandemic, but you know, the reality is this is an ongoing situation that we're gonna have to deal with for a while. And, you know, I was thinking about it the other day in terms of all the stimulus that's been put into the system and what that caused and what that's continuing to cause now that, that stimulus isn't there layer on the supply chain shocks. And I think there's a lot of things that we've seen impacting our clients and specifically for us and what we do on a day to day basis, deal
Larry (01:30):
Flow. As we always discuss confidence, drives the M and a market. I think we've been paying particular attention to our RBC colleagues. It's been a time of tremendous uncertainty and I, you know, thinking about it, what was interesting to me was that there was one very expected event, which is the fact that interest rates were eventually going to have to go up. And then we had the unexpected event, which was obviously the Ukraine crisis. Those two developments were on top of the pandemic, which has been a structural adjustment that the companies and investors and, and small businesses everyone's had to make. And so when we take a step back and look at how do all those factors coalesce in a way that enables us to think about what comes next, it's particularly difficult. It's a compounding of uncertainty. And perhaps the thing that, that really characterizes this as in contrast to prior market episodes of volatility, is that we all knew that the fed had a task in front of it, and it was gonna have to execute on that task. And the way that it's executed in the last few months in calendar 2022 has been somewhat uneven. If we're honest with ourselves and we have to look forward and hope that, um, whatever mistakes have been made or, you know, corrected, adjusted, and that we can create a little more confidence in the system that will obviously help consumers, businesses, and our favorite topic, M and a
Vito (02:59):
Yeah. And to echo your comment and build upon it in terms of confidence in the system, confidence in the outlook, which again, then allows you to have confidence in decision making. We always talk about CEO confidence, confidence in the boardroom, as they're making some of the key decisions out there. And if you look at volumes in the market from an M and a perspective it's off 40% plus year to date in 2022, obviously 21 was an all time year by over 20 or 30%. And this is still a considerably strong year, just based on the trends coming into the year. We saw a really soft second quarter and it's kind of continued through the rest of the year, but as we think about it right now, one of the indicators we always look at is, you know, the, the conference board's CEO confidence index. And when I look at that, you know, we certainly came into 20 19, 20 20, where it was below 50%.
Vito (03:59):
And I think a lot of that was due to uncertainty. It was exacerbated at the start of the pandemic. We saw an incredible jump to like an all time high of over 80% confidence on a scale of a hundred in the second quarter and third quarter, excuse me, really the third quarter and fourth quarter of 20 and into 21. And that obviously produced those volumes. We talked about right now, it's, it's dipped again below 50%. And I think that is just, just a lot of uncertainty. And with the clients we're talking to the boards that we're talking to, we're always evaluating what are your strategic alternatives? And, you know, we're refreshing them constantly right now with our clients. And I would say it's really difficult to make some decisions when you're really trying to get a grasp on your own business, how it's going to respond to different potential recession scenarios, the clients that are best positioned.
Vito (04:53):
They're the ones that understand where the levers are and their businesses, and are able to flex them. I would say the activity level in terms of M and a dialogue is quite high. Maybe there were some peaks in other points in time in 21 and things like that, but it's still a huge topic for everybody. And also there's a lot of issues that come around with that in terms of, you know, we've gone through a period of time now for the last few years where there's been a lot of internal focus and our corporate clients certainly have identified assets that they wanna divest. They've identified places that they wanna augment. And, you know, I, I think, you know, the, you and I can attest to the, the ongoing dialogues we're having with some of our key clients. There's a ton of activity out there and it's, it's across sectors, which is the other thing that we're seeing
Larry (05:43):
Whether or not it's a coincidence. I think we can divide 20, 22 from an M and a perspective into the first six months. And then the second half of the year, we're sitting here, obviously in the latter part of 2022, looking ahead to the end of the year, the first six months was a little bit of an overhang from 2021 in terms of strength. And one of the lines you had, which I thought was great. You said in the beginning of 2022, you said, well, if the M and a market comes off 20, 25%, yeah. Will still have the second biggest year ever. And that's how strong 2021 was. And indeed numbers came off 20 or 25%. And then you had another good line, which was when you look at backing out specs, which are the special purpose acquisition companies that had a very strong kind of moment in the first part of 2021 part of the, the ultra low interest rate environment and the excessive potentially liquidity in the system.
Larry (06:39):
But nevertheless, those were vehicles that drove a lot of M and a activity last year. If you backed out spec activity, actually M and a activity was more or less flat for the first part of the year off that record, 2021. But now as we get to the latter part of 2022 post, June 30, you know, maybe not a coincidence, but the equity markets have had some challenges. They did reverse for a while, but the high yield market breads have blown out a little bit. And as we move the second part of 2022, it definitely feels different that there is more conservatism. Most of it probably is driven by macroeconomics, but fundamentally as we sit here in sort of the third quarter of 2022, there's still some unanswered questions at the macro level. One of them is the impact of quantitative tightening. The Fred has not really begun to shrink its balance sheet in earnest.
Larry (07:31):
It's signaled that it's going to, it's tried to be very clear about its intentions, and then there's also the interest rate increases still to come. The Fed's been very clear that we're not done yet. So how the market reacts to those two things still remains a bit of a question. And that in itself is an overlay that when you're giving advice to a, a board where you're sitting in the room as a director, or as a private equity investor, trying to figure out, is this a good time to make an investment? You still have those big questions overhanging us. So then when you tie that back to M and a activity, generally 22 versus 21, it's sort of a tale of two halves of the year. But I think by the end of the year, you and I both believe will have a lot more clarity as to what the direction of the market is. My last comment on this is that there's just the X factor and the X factor is we all feel that things like the Ukraine crisis and the second order effects on geopolitics can have surprises. And that creates another element of volatility.
Vito (08:34):
Larry building on your point about geopolitical concerns, you and I have always been keeping a close eye on cross border activity and expected that that was going to be a driver of future M and a growth as the markets opened up a bit post COVID or, or more, more apropo post people getting comfortable with the COVID environment. And it's certainly been delayed a bit just given what's going on in Europe. But the other thing is I was reading an interesting statistic and this, you know, goes to some of the concerns globally. But if you look back at the high point of China investment into the us, it was back in 2016. And the number back then was something on the order of 27 billion of investment, which in the grand scheme of things, not a big number, but if you look at that number and where it sits in the first half of 22, that number is dropped to just under 2 billion,
Larry (09:32):
Do minimus. It's like a drop in
Vito (09:33):
The bucket, which is nothing right. And so if you consider that, and then you consider sort of the overall markets, there's still a fair bit that's out there, that's pressuring sort of future deal activity and, and just global integration. But what you're seeing is more transactions that are inwardly focused, meaning within the same country, or to be honest, amongst friendly or ally countries. So certainly in that same time period, though, if we look at sort of investment by the us into say, Europe, it's more than doubled. I think it's gone from like 60 billion to 150 billion. And so I think we're, we're seeing that growth and I think that's gonna continue and there's still gonna be opportunities there.
Larry (10:18):
And the strong dollar may reinforce that because of there's been a slightly different pace of monetary tightening as between the us Europe and Japan.
Vito (10:28):
I also think the clients are dictating where that growth is going because the clients we're dealing with are multinational. They're operating on a global scale. I think they're, they're certainly trying to make sure their supply chains are augmented and, and, and are diversified to make sure they're not beholden to any specific one region. And as a result, you're gonna see more diversified companies. And a lot of that's gonna occur through an M and a lens at the end of the day.
Larry (10:56):
Yeah. And another piece of the puzzle that is maybe different than what we've experienced in prior growth, slow downs or recessions, or, or whatever, or dislocation periods is that every corporate refinanced at extremely attractive rates, that was sort of a byproduct of the extreme and strong reaction to COVID where monetary authorities around the world enabled companies to really de-risk themselves by yeah. Issuing tremendous amounts of debt at these attractive generationally, low interest rate levels. So actually companies have strong balance sheets at the investment grade side and relatively low cost debt that they've locked in. Now, of course, as we look at a normalization of interest rates from the standpoint of financing of deals, you would be concerned about the fact that you're gonna ultimately be replacing very low cost debt yeah. With slightly higher cost debt theoretically. So, whereas something may have been accretive in the past, the replacement of debt to higher cost debt could be somewhat dilutive on the margin. Now that doesn't mean that what will feed into every single situation, but it's just a natural byproduct of higher interest rates. And the good news is that companies enter or a subset of companies that are not highly levered enter into this tougher economic period with very strong, in many cases, Bulletproof balance sheets. On the other hand, there are companies that push the envelope and that's why restructuring activity in the like could well increase as we head into a slower growth environment in certain sectors.
Vito (12:35):
Well, Larry, as you and I have talked about in the past and something that we predicted, we always thought that when we had the initial shock to the system at the start of COVID, that the recovery was gonna be much quicker and it was, and the banks were in a much healthier condition than they were in oh 8 0 9 during the financial crisis. And there was a, a lot of stimulus pumped into the system. And once deal flow started happening in mid 20, it really, um, stuck for a good 18 months. And, and I think that really made a difference for us. And certainly as we look forward, as you pointed out the companies and, and so forth are in a much better financial condition. And so I think they're better prepared to weather it. We also have a situation where the leadership has been through a lot of this, and they've had some time to make sure that they've got their plans in place.
Vito (13:28):
And the clients that are thinking about that, I think are coming through this in a very strong fashion. And I'm certainly thinking that as soon as the boards get a bit more comfortable in terms of the economic outlook right now, cuz it's really about the economy and where are we going to land from an inflation perspective? Are we gonna have a recession? I think everybody's saying there is a recession maybe already or not, but the reality is it's more about the resilience of the companies and how they operate. We're certainly seeing a lot of our clients having strong operating performance in this environment. And it gives 'em a lot of alternatives in terms of transactions that they can consider. I will say though, one of the concerns I have is having a constructive financing market. I think there's a lot of transactions to be had in terms of corporate deals that might be done on a relative value basis, stock for stock, more merger types.
Vito (14:24):
But there's certainly a significant amount of activity that we see whether it's private equity or clients that are going to fund their transactions, where they're looking to the financing markets. And I think the, the companies and, and the clients that have realized that the all time historic low rates that we had for such a period of time, they, they were incredible. And as you mentioned, a lot of people took advantage and refinanced the rates are still okay. It's not, not like we are, you know, back to the 1980s or something, but they need to reset their models and they need to understand what that looks like. But I also do think you need some stability for a period of time, and then you're gonna see a, a tremendous amount of deal flow. Because at that point, a lot of the financial players, for example, can obtain the proper loans and the commitments to get transactions done. And, and people will know how to price that risk as they're going into transactions. And, you know, I certainly think from our perspective, we're making sure clients are ready to pull the trigger as soon as there are windows in the market.
Larry (15:25):
I think the structural issue this time is really around the unpredictability of, of energy price inputs, and that feedback effect on inflation. And that's the central bank's predicament around the world because if things like oil prices, gas prices, food prices are affected by not just supply chains, but reconfiguration of economic relationships and trade relationships around the world because of geopolitics. If all those things are in motion, the concern is that you can't really control that as a central banker. So the way you can affect it is by putting downward pressure on demand, by squeezing the monetary spigot tightly and our, our economists talk about this all the time from an M and a perspective you have the need to reset financing markets in that type of environment, which we're in the process of experiencing right now. There's also an rebalancing in a way of risk reward from a buy side investor perspective, whether you're a debt investor or an equity investor.
Larry (16:33):
And then you also, in addition to resetting that you have the question of how economic activity might play out and feed into your own individual numbers in your company. Because even if you have a strong balance sheet and even if the overall environment for your sector is okay, if the central banks push their restrictions on monetary policy too far, or they have to push them farther to control inflation, then that could affect your ability to predict your own numbers. And you're always in an M and a environment going to worry about your standalone situation first and foremost, because it's very hard to do a deal while your own company is unsettled.
Vito (17:17):
You know, Larry, as we talked earlier, I, I would say the us market is off over 40% in terms of announced deal volume. This year, globally volumes are off over 30%. And I think that difference between the us and global where the us is roughly 50%, just under 50% of global volume is the European market. And the European market is off roughly 20%. And I think the, the couple of points we see there are one the impact of specs and the volume from 21 that was exaggerated in the first quarter of 21 from spec M and a transactions that certainly is impacting the decline in the us in a bigger way. But also I would say that the European market, if we look back historically probably had a tougher 20, 20 and 21, it was already a more depressed environment in 21, just as you look at sort of the UK exiting the European union and that certainly depressed and, and caused people to pause and wait to see what that was going to mean for their businesses and the economy in general. But, you know, we are definitely seeing a much more of a domestic focus amongst our clients. I would say that the us market still continues to be the most sought after market. And right now you're seeing the us players look at it that way. You're seeing Europeans look into the us quite a bit more. We are a little paused in terms of the us looking in the Europe, but I'm sure you're seeing some of the same things.
Larry (18:51):
Yeah. I think we talk about nearshoring and friend shoring. Does that mean that we're decoupling from large parts of the world, maybe on the margin and certainly directionally there's a reason that people are thinking about doing that and it relates to supply chain disruption, and it relates to geopolitics. And it relates to the notion that before COVID, the world was really trying to optimize efficiency and perhaps sacrificed a little bit of resiliency. So those themes of being a little more domestic, having your suppliers a little bit closer to you, having your factories in places that are less likely to be disrupted by geopolitical upheaval, that process in effect, a version of de-globalization is clearly happening at the macro level. And time will tell as to how much of an impact that will have on just the economy in general and M and a in particular, there is this difference in Europe, which is the shock of natural gas prices as Europe prepares for the winter and the need to effectively replace the energy that it was receiving from Russia is something that the us is a little more insulated from.
Larry (20:04):
So that's another source of divergence, but as you say, on the numbers, European activities, actually down a little bit less than the us, but that's from lower levels and it also affects cross border activity, but we could see a bit of a decoupling of, of Europe from the us. If there's more of a structural shock in Europe, then there's also at the macro level, we talk about Chinese foreign direct investment into the us, but also the Chinese economy generally has been affected by things like the zero COVID policy and also the property markets in China, which have been a driver of, of building and other things. And, you know, the Chinese economy is in a slower growth mode than it's been in quite some time. And that affects overall macroeconomics. So with that overlay, I think we all understand what's going on and we all can observe that, but all of these moving pieces do, as you say, move us more Vito towards deals that are domestic in focus, whether it's within the us or, or within a, a unit like the us MCA free trade zone, or whether it's within Europe or, or between very friendly countries, Europe and the us,
Vito (21:17):
I would say, look, we always talk about how M and a activity is doing relative to the prior year. And I think that's a disservice because the activity we had in 2021 that is a level of activity that is not sustainable on a long term basis. The reality is 22 is gonna be a top two top three year. You know, definitely if you look at where we are today in 22, relative to say the average of 2015 to 2019 sort of pre pandemic levels, we're still well above that. I do think it's going to take some certainty and lifting of sort of this concern of the forward outlook. Once we have that near term uncertainty lifted, I do think you're gonna see a rebound in accelerated volume of transactions. So I feel good about it. And then look what reinforces it as you and I always talk about is the conversations that we're having with our clients. There's no lack of M and a discussion, and there's more and more to be done. And ultimately being in that room with them when they're making some of the most critical decisions in the lifetime of their companies is where we wanna be. And, and hopefully we can add value
Larry (22:32):
Beto, always a pleasure chatting.
Vito (22:33):
Thank you, Larry. This was great. Looking forward to more.
Speaker 3 (22:41):
You've been listening to BC's M and a inflection points. Join us for more analysis about what's moving the M and a market in our next episode until then thank you for joining us. And if there are any topics we discuss that you'd like more information on, please contact us directly or visit our website at www dot RBC, cn.com.