Stakeholder Impact: Regulation and Activism on the Rise - Transcript

Vito (00:07):

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 Sperduto co-head of global mergers and acquisitions here at RBC capital markets. And I'm joined as always by Larry Stein, deputy chair of global investment banking. Hey, Larry, it's great to get together today to talk about our favorite topic.

Larry (00:32):

Yeah. And to continue our ongoing discussion. And, and we hope help people think about, uh, some of the same questions we're asking ourselves on M and a inflection points. We talked about how there's always a little bit of a time lag when a new administration comes in and we predicted that antitrust scrutiny in the us would definitely rise once the government was staffed.

Vito (00:53):

One of the things that we're watching closely is how the different regulatory agencies, the FTC or the DOJ are evaluating transactions, the largest players, especially in the technology space, as we know, are getting increased scrutiny. It's even when they're buying smaller assets. Because if you look back in history, certainly there's been criticism on the part of some of those agencies on companies like Facebook or meta for the acquisitions of businesses, like an Instagram, where they bought it at a certain size. It was certainly not the size of entity that it is today. And now they're looking at it as such a large control stake, and they're trying to figure out how to manage that. And so it'll be interesting to see how the current administration takes on these policies and, and how they apply them. And in a similar fashion, as they consider regulating transactions from overseas, through CFIUS, through the committee for foreign investment in the United States, as an example, the way that we regulate transactions into the us is certainly going to impact how us companies are considered overseas.

Vito (02:05):

And we're seeing many more jurisdictions come into play. As we go through the transaction approval process. One of the things we've counseled our clients are, I would say two very basic points. One take the estimate that we would normally make in terms of the timeline from announcement to closing and extended, because we're seeing that that has become the norm, not just in the us, but in other geographies. And then two, the transactions that are going to be a concern that are going to receive incremental scrutiny. We kind of know what those transactions are. There are certainly a cottage industry of professionals and experts that are pretty well placed to assist clients in, in evaluating those risks. And, you know, look, I, I, I would love for those individuals to be right all the time, but I think it is a bit unpredictable. And at, at the end of the day, I still think good strategic transactions get done. And it's just a matter of making sure that you've planned properly. So, I mean, so those are some of the things we're seeing right now.

Larry (03:10):

It was about a year ago that the Biden administration came out with its whole of government review of antitrust type of, of transactions, trying to, you know, not necessarily eliminate M and a, but use different approaches to assessing it. And so I separate the antitrust environment really into two broad categories at this moment. One of them is the big tech players and they are looking at their own sort of general concern about antitrust legislation from Congress, as well as antitrust enforcement from the FTC, the DOJ and, and others. And I think the what's interesting is they continue to, to do transactions. So you see Microsoft Activision as one example, meta, Amazon, they've all bought companies recently, and the government has challenged some of those transactions and used somewhat novel theories, one potential competition, which, which hasn't been really, uh, argued in in many decades. And without commenting on the merits of any of these, it feels as though the biggest tech players, you know, just wanna continue to see what they can do from an M and a perspective while they're considering how that feeds into their broader regulation or reregulation by the government.

Larry (04:28):

And I, again, I've been around a long time. So I remember the breakup of the bell system, which started actually under a Republican president, you know, Ronald Reagan. And so there's always the concern on the big tech side of proactive legislation to break them up or court supervision. So they have to take that into account other companies don't, but those companies though still have to be cognizant of the risks of antitrust. And we talk to boards all the time and maybe less so to private equity buyers, but certainly to public company boards. The most important thing almost always is certainty of closure. If we knew that a deal was gonna happen, would we take 5% less of another bidder who had a big antitrust issue? I think most boards advised by most law firms and most leading investment banks would take the discount for certainty and certainty is important.

Larry (05:18):

Why? Because if you don't have a deal that gets closed, your company's in limbo between signing and closing there's effects on your employees, there's effects on the current operations of the company. And you've already said, you know, my destiny is better served by a deal than it is alone. And that doesn't mean companies can't rebound from that. And one of the great examples is T-Mobile which at and T was not allowed to buy. And then they hired John Leger and they did a great job rebuilding the company, but it was, it was very fragile at the time. And any time you, you really don't want to go through a deal being shot down if you can avoid it. And so that creates a bit of deterrence on the margin and that's, the regulators are well aware of that. And they're trying to create that sense of deterrence,

Vito (06:05):

You know, as we think about it by sectors, Larry volumes year to date are off over 40% in the us over 30% globally. What's interesting is when you break it down by sectors, given some of those very large mega deals, the Microsoft acquisition, the, the Broadcom acquisition, the technology sector is actually up over 20% year over year. And it's other sectors that are down more than those numbers I mentioned. And like you said, they're trying to figure out how do I push the envelope a little, how do I expand into some key sectors, especially the way that they look at the future. And I would say in the technology sector, especially some of the largest players, they are probably more adept and are more skilled at a forward look because their plans and sort of the advancement of technology where they're gonna be in five, 10 years plus are certainly built out to a great extent. And they're always trying to test what's coming next. I'm not even gonna get into talking about a virtual world. <laugh> just given that, you know, I'm just trying to get my arms around that. But I do think it's gonna be very interesting to watch. The other piece is, I mean, those large deals get the headlines, but those companies are making so many acquisitions throughout the year on a regular basis to augment certain technology or product gaps

Larry (07:27):

Or what we call Aqua hires, where you're acquiring a company, who's got a good staff of software engineers. The whole ecosystem of Silicon valley is really set up for that. And that's particularly the case when the IPO market is so weak and where private valuations have come down. So if we try to synthesize what's going on for a private successful company, number one, valuations in the venture market have come down significantly, which is normal because the overall valuations have come down. But that means it's harder to raise money or more, much more expensive to raise money, especially as venture capitalists, get a little bit more conservative. And it also means the IPO option may not be as readily available or as predictably available by the time you think you might need money in the next year or so. And so that leads you to really consider M and a, and we've had many situations over the years where there's dual tracks and you think about an IPO and you think about selling a company simultaneously, but one of the tracks is not particularly credible as we sit here, you know, in the fall of 2022, just because the equity markets are not really receptive and certainly not evaluation levels that people saw in the recent past.

Larry (08:42):

So that means that larger companies in Silicon valley are the logical ways for private companies to themselves monetize their investments, or take their own own business to the next level as part of a bigger entity. And that's exactly what the government is laser focused on. So I think the tech numbers you referenced are driven by those two giant deals, but the underlying sort of need for companies in Silicon valley to, you know, either potentially sell themselves or raise money at less attractive valuations privately means that there will be an incentive for them to sell themselves at fair prices to strategics. And that, that will lead to a lot of scrutiny in Washington.

Vito (09:25):

I do think one of the interesting things we've had to deal with in this period of volatility as valuations in the public markets have fluctuated and, and in a lot of cases come down. When we're talking to clients who are considering acquisitions of private companies, it's been very interesting to have the dialogue around. How do you think about valuing those private assets? And there is still currently a dislocation, and I've heard a lot of good examples. One of our colleagues talked about it in terms of the real estate market. And, you know, everybody's like, well, you know, back in March prices, we're at these all time highs and why am I not getting that price from my house? Well, the reality is there's a lag in the valuations. I think the buyers need to take a look at those assets and figure out how does it fits strategically?

Vito (10:15):

What happens if I don't get this asset and someone else does. And then is there an opportunity to get a comparable asset at a different value? And these are all questions we're dealing with real time. I know you and I talked about one client that I'm having this exact dialogue with right now. And they are struggling because the valuations in the public markets are off 20%, 30%. And they're looking at an asset that is coming along at a time when it's a fairly unique asset. And we, you know, rarely try to use that word, but it is. So the question is, how does that make sense? And the reality is the economics of doing it based on the fact that the buyer here is a very well capitalized company. They have tons of cash on the balance sheet. They can easily pay with that. They're sitting there with a credit rating where many banks, much like ourselves would certainly finance that at a very attractive rate, even relative to historicals.

Vito (11:10):

And then they're trying to make a decision. And so ultimately it's a, does it fit strategically? What happens if you don't make that acquisition today is your business or where you plan to be in the coming year is gonna be hampered. And, you know, look, I, I think you need to be flexible in terms of how you consider this. And the reality is you need to take into account that valuations for them, haven't adjusted as quickly. And we can make all the cases in the world to that seller, but they don't have a public market currency. And, and as a result, you need to think about what that means. So it'll be interesting to see how we deal with that in the coming months and next year, cuz I think that's gonna become a bigger issue as, as there's volatility out there. I do think, and I've been going back and forth as you and I always debate whether it's our corporate clients or our private equity clients and who sits in a more advantageous position in this market.

Vito (12:06):

And there's different thoughts there. I would say, you know, look, our, our private equity clients are more often doing transactions. And so they're always in a position where they're, they have the latest and greatest art in terms of how to do things. They're thinking fairly ahead, you know, and they're generally leading indicators on a lot of topics, but at the same time, the financing markets are difficult right now. And as we talked about, a lot of our corporate clients are probably better capitalized and they have an opportunity here. There's a window where they're in a better position to do some transactions. And despite the fact that the dry powder on, uh, private equity almost unlimited, it is because we talk about dry powder being at an all time high. Right. But then that doesn't take into account the ease with which they can go to their LPs and extend beyond what they normally do.

Vito (12:56):

And the other thing I've, I've talked to a number of clients on this topic when they asked me, well, what are the private equity firms doing? And at the beginning of the COVID environment in 2020, we saw a lot of private pipes into public companies though. Not necessarily as many as we expected. Yeah. I, I think there was an early trend and I think there was companies that really needed some, maybe it wasn't rescue financing, but they were trying to solidify their balance sheets. There was also at the start of all that everybody extended revolvers, everybody drew down revolvers, to be honest, just to make sure cuz they were concerned, they didn't know where this was going. And as I mentioned earlier, they didn't know if the financial system, the banking system was going to be healthy when it became apparent that it was fine.

Vito (13:41):

I think they were in a good position. Those deals happen, but they pretty quickly got back to their sort of bread and butter, the typical transactions, they just started finding opportunities for LBOs. They were set, uh, looking at the portfolios of their peers and seeing where they are, their companies that make sense to acquire. They were looking at selling to each other. Yes. And we saw a spike in, in sort of fun to fund transactions between different private equity firms. We also saw an incredible amount of corporate divestitures. And as I mentioned earlier, that's actually picked up as corporates have increased their review of their internal portfolios in this period, especially in 20 and 21 when things were a little quieter for them. The other thing we're seeing with these record levels of dry powder in private equity firms is they're thinking about alternative places to put money.

Vito (14:33):

And I think in the middle of 22, when we started experiencing volatility, especially in the second quarter of 22, and then as we kind of headed into the summer, we saw a number of firms, basically take a pause and look closely at their existing portfolio. Maybe there were opportunities where they were seeing the trading levels of debt on their companies trading at levels that they just knew were inaccurate. And they took advantage of those anomalies and went out and bought in outstanding debt and they bought it at discounts. They know it's gonna get paid a maturity, it's an incredibly attractive piece. And it's also an asset they know well, but now they're starting to look around and say, okay, when is this gonna open up? When can I get back to traditional? LBOs you're certainly seeing some of the players out there. If there's an asset they're incredibly interested in, if they're able to put together a financing package or maybe say, look, I will backstop this transaction with my funds from an equity perspective.

Vito (15:41):

And then once I have the deal locked up, I'll go out there and source the debt financing for the transaction. And then also, you know, look, we've seen a huge pool of capital pop up from the direct lenders that is unprecedented and only growing day by day. And many of these private equity firms have also set up funds that are doing that as well. And, and what I mean there is that in terms of doing LBO, they at the time that they're signing the transaction, they already have the specific debt structure lined up from lenders that are going to mainly hold those funds versus from a bank like an RBC where we would give them a commitment and then place it sometime between sign and close where the terms are still a bit to be determined.

Larry (16:27):

And that's a compliment to the syndicated finance markets, particularly during tough periods like this and regulated banks like ourselves have limits to what, the amount of risk that we're willing and able to take. So that has definitely been an interesting phenomenon, but back to Washington and private equity, because you would think that if you increased corporate market share enforcement of antitrust, that that would actually on the margin given advantage to a private equity buyer cuz a private equity buyer. Usually it's a financial standalone vehicle and they're buying a company than an industry. They may not be in many of our private equity clients have domain specializations now. So they may be buying multiple companies within a domain, but they don't always compete against each other directly. And even, even when they're buying them, they don't approach the level of, of antitrust market share thresholds that all large companies do.

Larry (17:18):

So does that mean that private equity should be the preferred buyer right now to your question, but in Washington there's an awareness of this. There's an awareness of dry powder and as much as they are suspicious of corporate concentration at the same time, they certainly don't wanna see private equity necessarily buying up even more of the economy at robust levels at a time when that could lead to job losses or it could lead to sort of political questions about the influence of private capital. The administration is trying to constrain private equity in a way that perhaps previous administrations have not. It's just part of the general desire to again, take a whole of government approach, which means evaluating deals, not just on the basis of market share in the case of some of the challenges and the potential competition, maybe that'll stand up in the courts, maybe it won't, but also in terms of the effect on public policy, more generally such as ESG related considerations, labor considerations and, and other things that are, that are relevant. So the whole of government philosophy that Biden enunciated is sort of in the process of being implemented, but private equity is definitely part of that net that they're extending to try to catch certain transactions.

Vito (18:40):

As I was saying earlier, Larry, I think the, the private equity firms recognize trends early. And I do think that they are thinking about the scrutiny that they're getting, not only from Washington, but just in general from a public perception. For example, KKR has been very vocal on expanding the shareholder base at their companies and making sure that more of the employees are part of it and others are doing, you know, similar programs, but they're trying to make sure that at the end of the day, there's a broader participation in that upside. And I think they're recognizing that that's a model shift that needs to occur. I would say it's been unfortunate to see some of the political attacks that have been escalating on the ESG concept and it's become sort of a easy firebrand, including a number of state's attorney generals, criticizing BlackRock and their approach on it.

Vito (19:33):

And if you follow what BlackRock is saying is, you know, they're basically saying, look, I'm not trying to set specific targets or guidelines for these companies, but we do think we wanna understand how companies are thinking about adapting to the climate change environment. How are they thinking about energy transition and the easy way for us to understand it is we understand the metrics that they're focused on. And so I do think that that's a topic that's being looked at closely as we've always talked about. And, and I tell clients quite a bit that ESG is what we're calling it today. We've always talked about transactions being more successful when you focus on the broader stakeholders, all the constituents and not just the shareholders for sure shareholders are a key constituent, but so are the employees. So are the suppliers, the community they're working in and as you and I know the best M and a transactions in terms of success post the transaction are the ones. When you think about all those stakeholders, when you're thinking about how it impacts everybody, and it's more of a merger, even if it's an acquisition.

Larry (20:43):

And, and I would say that because of the energy dislocation, which arose as a result of Russia's invasion of Ukraine, all of a sudden energy policy and ESG are front and center, environmental renewables become more important even in, in the public mind, but also more difficult in the short term to meet the energy demands. And the inflation impact is immediate and visceral. It's almost impossible now to evaluate a deal without looking at that impact and what the second order consequences are of absorbing a target. If you will, you need to really understand where that's going to put you in the next couple years from an ESG perspective,

Vito (21:25):

As we look towards the second half of the year and going into 23, you know, we've talked about how during the pandemic activism activity has been a little more muted. And I think a little bit at the start where everybody was trying to figure out how they were gonna play, the definition has become blurred. And I think some of the activists now have multiple strategies. They're more and more working very closely. For example, with private equity players, they're more and more acting like a private equity firm or even setting up funds like an Elliot has a specific fund that is more akin to a private equity fund. You know, they've certainly had a lot of capital and they're trying to figure out how to apply it to different strategies, but we are seeing some developments where they are gonna be better positioned to look at campaigns and down the future.

Vito (22:20):

And, you know, as we know, when there is volatility in the markets and certainly the underperformers are carefully planning to make sure that they are well positioned in the event that they do get a call from an investor or an activist. And we're having a lot of those conversations as you know, trying to make sure our clients are well educated on the topic and how to respond and look at the end of the day, the best defense is making sure that you've got a great understanding of your business. Your board is extremely well informed education of all your constituents is, is the best defense at the end of the day. Yeah. And so I think we're watching that closely, cuz I think there was a dip in the number of, you know, true activist campaigns in the first half of this year. But we would expect with the rise of things like universal proxies, it makes it simpler for investors to raise an issue. And again, that blurring, there are a lot of funds that want a greater role and a greater access in communicating with companies and boards

Larry (23:23):

And activism is back. The pressure on the buy side is intense because when the overall equity indices are down in any given year, which they are, there's a concern, you know, you're losing clients money and or underperforming the indices. And so that puts tremendous pressure on just the rank and file buy side universe, which includes, uh, many, many large and, and influential institutions that we wouldn't classically called activists, but who have objectives that are very aligned with the objectives of the activists, namely get the stock price up. So it's a very good discussion to have with companies to prepare for this. And companies have become more sophisticated because activism has been ubiquitous after the slowdown. I mean there was a slowdown, uh, post COVID and into the first part of this year. But I think you, and I would say, there's no question that that activism, particularly as we look forward to the next proxy season annual meeting season tends to be in the spring nomination deadlines tend to be in, you know, around Valentine's day or thereabouts. And so we can see this over the next year or two with the universal proxy rules being a real factor. And also in a way that's now an organic part of the market. It used to be something that was somewhat exotic. People were always used to shareholders expressing their views and people were used to hostile bids, but activism over the past decade has become much more embedded and established in the market. And it doesn't feel like, like that's gonna change. And so definitely an ongoing topic of interest and conversation.

Vito (25:00):

And then also obviously the capital allocation topic, you know, you should use the ample cash you have on the balance sheet for stock buybacks. And as we know, given that the cash on corporate balance sheets is at or near an all time high right now, you know, we certainly are seeing that happen quite a bit. And, and I think it's been a, a preferred route to get board representation in a lot of cases. And so we've seen that play out, but more often than not. I think what we're seeing is that they're going in and looking for a more detailed dialogue, a longer hold period, which is pretty interesting to see. And they've already had all those conversations and they are certainly using it to their advantage. But again, it's, it's just an environment where that constituency, those shareholders, they, they're not looking to be passive. They wanna be part of the conversation. And I think the companies that are dealing with this well are the ones that have a good articulated strategy. They are constantly reflecting how they're doing relative to that strategy.

Larry (26:07):

And we always say, it's good corporate hygiene to think like an activist and evaluate yourself as if you were an activist on the outside looking in, correct.

Vito (26:16):

I'll be watching that quite closely as we go into the remainder of 22 and, and into early 23

Larry (26:23):

Beto, always a pleasure chatting.

Vito (26:24):

Thank you, Larry. This is great.

Speaker 3 (26:32):

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,