Vito
Hello, and welcome back to Strategic Alternatives, the RBC Capital Markets podcast. Today, we've been talking about the consumer and retail landscape, and we have with us Douglas Trauber, global head of consumer and retail here at RBC, and Hugh Paisley, co head of US consumer and retail, and as always, I'm joined by Larry Grafstein, deputy chairman of Global Investment Banking. So, gentlemen, why don't we get back into it and maybe start with you, Douglas? Let's Let's talk about some specific areas of consumer and retail where you really think there's gonna be heightened levels of activity from our clients, and I know you you know, Just given the conversations you've been having and that we've been out there having with your client base, feels like there are some areas that should experience some good deal growth.
Douglas
Thank you, Vito. Let me start, and then I'll turn it to Hugh because, again, the a couple sectors. One, because there's been some activity one where it's going from here in 23. We mentioned grocery. Still a highly fragmented sector. We had two deals last year. One is still in the market, Kroger Albertsons, which, catalyzed another deal, which if that gets closed, which was CNS Wholesale buying the cast off stores, and there was a 3rd deal. That deal, as I mentioned before, was a deal that was really focused on driving efficiencies To enable them to become more competitive with the big 3. Within the same sector, RBC sold a regional top 10 grocer called Southeastern Grocers known as Winn Dixie in the South, and we sold it to Aldi.
Douglas
Aldi is a global leader in food retail. It's a one of the most Prolific in terms of its box count in the US, 25100, and this was a story about trying to be competitive, but trying to accelerate growth. They had an opportunity to buy a business with 400 units. So if you take those into one, as we are through, and we have more visibility into the environment. I think you'll see additional counteractions to some of the deals we've already seen, and I think under the cover, we're seeing some of that where how can I for the differentiated grocer, how can I get more boxes? For those that want to grow regionally, where can I acquire, and and we had two deals like that prior to the last couple years as well.
Douglas
So I think that's one area of growth in and a that will continue. Convenience as well would follow the same pattern. I think there is a a view of, and no one has to crystal ball, of where does this utopian performance sort of decline, and I mean that by saying CPG or or cents per gallon margins are very high, and they've been high since for the last several years. It's driven significant cash flow. It's allowing regional players that are are strong to think about whether now might be a a better time in a good environment, in a better Market environment to sell. So those two sectors, I think you're gonna see continued consolidation, and they're the two most fragmented, sectors.
Douglas
There's a third, and then I'll turn it over to Hugh, which is the the fallen angels. So if you go back to COVID and and pre COVID, we had a prolific period of IPOs in ecommerce companies. Though and most of those were e easier companies to build, Less capital intensive, apparel oriented, technology focused, and some a little bit more so from a delivery perspective. I think. As we move forward and we think about capabilities and we get, again, seasoned market values so that we know where those really are settling out, I think you'll see more in that space on the corporate side as well, and maybe on the services and where sort of the the growth side of of retail, I'll turn it over to Hugh.
Hugh
Again, I keep saying I feel like a broken record, but in specialty, it really depends on which segment you're in in terms of the trends. But I think there's two primary drivers, and I'll I'll break it out into buckets of greater, and a volumes, and I think that that comes from the corporates and from the financial sponsors.
I think from the corporates.
Hugh
You know, if you'd really think about we're in 24 pre COVID as a year, 2019 was 5 years ago. There's much more greater focus and greater certainty on the areas of where they need to win, and then there's an honest assessment Within their portfolios of what's not consistent with those objectives, and so, you know, we saw a number of disposals, you know, from corporates Over the course of 23, we could expect a continuation of that. We also expect to see greater focus and energy around investing behind the core, and that might be in the case of capabilities, that might be in categories, and certainly thinking through demographic trends to get ahead of where the puck is going, we also see really for the need of synergies to drive additional cash flow to increase investment And where they can make organic, you know, organic investments.
Larry
Let's talk a little bit about an issue that is common to all industries, but is relevant as well to consumer and retail, which is obviously the antitrust scrutiny enhanced antitrust scrutiny That we see out of Washington, out of the FTC, out of the DOJ, and we know that your industries are highly competitive, As you both said, somewhat fragmented, and it's and and tough tough business when you think about the types of conditions that retailers have had to react to just in the last Few years, it it's quite extraordinary. But when it comes to transactions, talk a little bit to us about how. How the atmosphere, the regulatory atmosphere in Washington around deals factors into the thinking of some of your clients. I'm sure It's more relevant for some than others.
Vito
And maybe, guys, as you think about that, I'd highlight a point for the audience here, which is. When we look at sort of the proportion of deals that are consumer and retail back in 23, I think 11 percent of the Transaction volume in terms of dollar volume of deals came from consumer and retail, and I talked about energy and health care being the largest sectors, Gers. But only about 3 percent of the 10,000,000,000 dollars plus deals came from consumer and retail. So clearly, they were more prevalent in other sectors. I think the concern as we look at it is, In some cases, the FTC and DOJ are going after more strategies where folks are rolling up and consolidating and not just simply looking at the largest players, and so when it's impacting the consumer, they have a heightened interest. So we'd love to hear your perspective.
Douglas
It's a terrific question, and I'll take it from a couple points. One is, as we always think, historically, what is the FTC's focus is to, make sure that consumers are protected, that prices stay low, and that you don't reduce competition. They've added an element to say, you know, Let me make sure that labor and employees also are competitive and are well focused on. There's a long history in retail, and this goes back to Really, the what I had said before about retail Darwinism, where in sectors you get to one, two, 3, 4 players and what happens to the protection. The scrutiny over the last over this administration, we think, is heightened, and we think it's in some ways and I'll talk about the client maybe too much so.
Such that they're they haven't broadened the definition in certain areas, and as a consequence of that, are making decisions. That may not be in the best interest of consumers. Companies that we talk to today have two issues, and they are not entering into deals. Because they see the scrutiny, and they are not entering into deals because unless it's absolutely deliberate, absolute Synergize and required, they don't wanna wait 12 to 18 months for a deal to close. So there needs to be a better approach to that, and I think because of that, and if we start to see other deals get through, I e at Kroger Albertsons, I think you're gonna see more activity. I was just having a conversation this past week where a client wanted to get on the phone with an FTC council to get some answers On something that actually did get through and how did it get through.
So I personally think that clients are very deliberate into not. Entering into a deal that they think is going to be a problem. Let me give you an example of one going backwards, and this goes to the change environment and definition. I think 2017, Walgreens, announced that they were going to acquire Rite Aid. That deal one its whole totality was blocked. You had 3 players left. You had two dominant players. In Walgreens and CVS, and you had Rite Aid. As a consequence of not being able to get that deal done, they split up the company, allowed it part part of it to be sold, and you were left with a public company that was undercapitalized, inferior in most every way to the other two, and you can see what's happened to that business subsequent.
There's enough competition across retail to keep and in fact, to drive value to take it lower. Take the Kroger Albertsons deal. That's been in the FTC for over a year. Logically so, make sure that we protect consumers. The question there is, can I broaden the definition? So in that case, I'm a grocer. Historically, Walmart, Aldi, discounters weren't included in that definition, Let alone, you know, the the presence, even though it's small, of what Amazon can do. What we know is Kroger has invested for 15 years in price To to close the gap with Walmart. The FTC is focused on if if you do that, the focus will go away from from that that that focus.
Larry
So we sometimes see with the DOJ and and the FTC, they sometimes apply.
You know.
Stricter scrutiny to high profile companies, and consumer companies, By definition, are known to the public, and it's a signal the regulators want to send, or generally, maybe as a as a political message sometimes, That they're being tough on on antitrust, and and we just saw recently the Jetblue Spirit merger was, which again we A fairly visible industry. The challenge to the deal was upheld by the court, and one of the parties to that has even said that they might have to do a restructuring as a result of that. So We understand that happens. We understand that factors into to boardrooms, but many of the sectors of your industry are are still very fragmented And should sort of fit below the the thresholds that that attracts scrutiny. But how much are you seeing the the concern about, You know, being made a public example, inhibiting activity as opposed to some of the other things that you've mentioned About the need to, you know, to drive growth as pricing power is restricted.
Douglas
I think it's an it's an inhibitor. Large companies that otherwise they take they they will take counsel views, and it depends on how what degree and what overlap and You know, what those businesses are, who is it, what the competitive environment one, but I do believe that one and A is constrained in this sector by the view that larger companies will be having more scrutiny, and it's more about the length of time And the the the logic that you're gonna have to go into and most likely fight this in court, and so I do think, you know, and the and we can talk administrations too, You know, whether Biden administration that is pro labor and you know, seems to have a little bit more scrutiny, I think that's that's a little bit more preventative than maybe If you had a different administration.
Vito
Douglas and Hugh, I think we always talk about the prevalence of the corporate buyers versus private equity buyers, and Certainly, in 23, we saw the strength of the corporates, and Douglas, as you highlighted, the balance sheets are in a good position. They feel, you know, they have Cash, they're able to finance, and so I think corporates took advantage over private equity firms in one, and you know, where some of the private equity firms had capital constraints from a financing market availability perspective, and we saw corporates really pursue some transactions where they didn't have as much competition. How are you seeing it on a go forward basis? Do you see a balancing? Do you see the private equity firms as having sort of pent up demand in Terms of capital to put to work in your sector, are they looking more at distressed opportunities or strong growth opportunities? Would love your perspective on the markets.
Douglas
There's a lot of capital on the sideline in private equity, and there are big consumer focused groups looking across. There has been a risk off appetite in certain parts of retail for the logical reasons of where the growth is, the competitive dynamics within certain sectors and the scale of the corporates that are in those sectors. I think for private equity, the influence is how. I'm focused on either a A differentiated business that has a really good competitive advantage and can grow. Generally, I would argue that it's more about it used to be more about, Can I find an undervalued business that I can create more value to, and there are some of those, you're seeing one in the market today, you know, the rumored Macy's deal.
There are examples where you might or might not see private equity, but I think for the most part, they are focused on growth areas that they have an exit, and if they're gonna buy it today and a corporate's not buying it today, I'm not sure if corporate's there tomorrow. So let me think about those that I might be able to Either make as a platform consolidation play, the end work can take public.
Hugh
Just to build on Douglas's comments, I mean, certainly, where we've seen financial sponsors play Consistently is where there's multiunit growth stories. Companies with proven economics, ability to transport and replicate at scale, and white space to grow. A lot of those investments as we look backwards in 2023 required just equity checks and very little debt, and so that was not a constraint. I think what we haven't seen, that as we look out over the next 12 or 18 months, is the larger businesses that might carry, you know, what was in the past 4 or 5 times leverage. Well, when interest rates were low, You could still buy multiunit growth stories because the cash flows would work. The challenge when rates are high is that that interest burden absorbs a lot of the free cash flow that is used for investment, and so what that created is a disconnect in valuations.
You know, I think that the second piece that Douglas raised was around exits, and so there's a lot more focus on exits, and what we've seen in retail over the, you know, over the last several decades is that There's a cycle of smaller companies being able to access public markets sooner, and then it flips back to larger companies, and I think what we've seen, you know, certainly over the course of, after the the boom of activity that happened in 21 when Interest rates were very low, and a lot of small companies could access public markets. We see, you know, at least at the moment, a higher bar in terms of The size of company that can go public, and that's gonna create just more recognition that, you know, if you are Holding a portfolio company, and you've held it now for at least 5 years just to get through the COVID volatility And things have now settled down that that's gonna create some activity on the sell side, and then I think buyers are looking for how to be more creative about buying to narrow that valuation gap, and that might mean that private equity firms roll a little bit more, you know, into these investments to play for some of that side for future, and I think that also there's a lot of smaller companies that, you know, kind of recognize that their exit is no longer an IPO And that they may need to consolidate and be part of a roll up to be bigger to eventually access public markets.
Larry
Yeah, and that's a theme across Industries of of large private companies, the cost of private capital is more expensive in the last couple of years, and in consumer one retail, you always have new concepts that are being financed by growth capital, some of which managed to very quickly become trendy and become More valuable, and those companies have to really calibrate the difficulties with the IPO market right now and think about their Their medium and long term ability to grow.
Vito
Look, Hugh, I think the egg and Douglas, the exit point is tantamount. I would say that, Hugh, you mentioned one being a peak year from an IPO perspective. When you look at one and 23, I mean, they were, like, effectively one 10th the volume in terms of what you saw out there, and and the the large names that did get out did not have the best performance, and I think that put a damper on the market. I do think there's a pent up volume as we've talked about, and we've used that word a lot, of businesses that are looking for exits. Hugh, you mentioned a little bit in terms of pivoting where the public markets might not be an alternative pivoting to a sale.
How much do you see that pressure increasing as we go into 24? Because I think one of the things I'm noticing, and Larry and I were talking about this recently, is that. I would say, especially our private equity clients, there's a fair bit more pressure to monetize certain assets this year and not wait for the optimal window.
Hugh
That's a great point, Vito. I mean, just building upon that is that, you know, when you look at the private equity business, You know, they do focus on closing out funds and raising new funds, and you know, with the cost of capital increasing, The environment of raising new funds has become tougher. Funds are still being raised, but the bar is higher, and If you're sitting on a lot of investments from a previous fund that you haven't shown monetizations, that's where we're really seeing pressure to, You know, to come out even if it's not necessarily the ideal exit time time frame, but to show show progress in terms of Monetizing some of those investments within an older fund.
You know, I think that that's again, you know, as we start to see the volume of activity in 23, When you look back over the last couple of years, it was really hard to project your business, and so, you know, that was a preventative measure just in terms of being able to go out to And and really be scrutinized and you know, as we move into the second phase of diligence. You know, I think now you see several quarters of kind of a new trend line, and you're able to Project your business with a little bit more confidence, and so that's gonna be another thing that's gonna be a driver as we move into 24, and Hugh.
Vito
Just to Maybe, a little shout out for some of our internal RBC Capital Markets people. Maybe, tell the listeners a little bit about how we're using RBC Elements and sort of some of their advanced artificial intelligence technology and and analytics to really extract some meaningful data and implications for our clients just to help them position their businesses.
Hugh
It's a really important point. We've talked about AI. We've talked about predictive technologies, and we have, internally a group of data scientists that sit in between investment banking and research That we branded RBC Elements, and they're an incredibly valuable tool for a number of companies, both small and large, To really do an outside in approach of what's happening in terms of overall web traffic on both an absolute and relative basis to competitors, You can track it regionally, you know, by state, by county, by demographic, and really, you can measure overall sentiment based on Social media platforms, and it really can create a very nice story. So even in categories where for macro reasons, You know, the trends are less obvious because of the the headwinds that either happen on the revenue side or on the gross profit margin side For no other reason than macroeconomic factors, the underlying consumer strength of the brand, and receptivity of the value proposition becomes highlighted through that digital information.
Vito
And, look, I think for the audience, this just highlights that we're always trying to figure out how to best position. Our clients as they're pursuing a transaction and really trying to think of new and innovative ways to highlight how their businesses are performing and highlight the value that they're bringing to the consumers, to their clients, and the like, and I would tell you if you're interested in hearing more about RBC elements, please reach out to us directly because I think some of the alternative datasets that they're using to provide unique data to our clients is quite ahead of of, where a number of people are today.
Larry
So we started off talking about the consumer, the frame of mind of the consumer in this market, and To some degree, consumers are affected by politics and the political environment, as well as geopolitical developments. That can affect things like the price of oil and the price of gas, and so one question for you.
Hugh
Looking at at the overall.
Larry
Atmosphere, the environment for the consumer. What do some of our more sophisticated clients Think about the impact of global events, generally, the presidential and congressional elections coming up this year. How will that factor into their thinking about transactions and positioning themselves?
Douglas
When we look at it, and I think There is an ability to look a little bit retrospectively because we've seen if we expect it to be a a Biden, Trump. General election. We can look back at both administrations and see what happened. Our corporate clients expect potential heightened tensions between China and the US Post election, and that's you know, it's in the some of the scripts we're seeing, and what does that mean? Well, if you go backwards, it's already in. Some of the data today, but we also can see what happened before, which is tariffs, and if they change and they go up, and how that affects, In particular, obviously, imports from China, how that affects investment in the US as a consequence.
The geopolitical dynamic that you mentioned, Agreed. I think it's an input dynamic. I think it's it's there's two elements to it. One is what happens to inflationary factors like oil, and then what happens to markets? Capital markets that can be closed or be volatile depending on what happens in in various regions, in the world. So I think. I I think they're watching, but anticipating what that might, you know, offer post election.
Hugh
Yeah. I think There there's two pieces to it. I mean, just to add on to what Douglas was saying. I think the first one is just the election, and and we talked a little bit about earlier about, exits And just what that means for IPO windows. I mean, just by virtue of what retailers do, and there are certain windows, you know, particularly if you're selling goods versus a services company where as you start to enter into Q4, it becomes tricky. That's only magnified by the fact that there's an election. So then you start to look at what 25 looks like and what that IPO calendar one, and then you balance that versus Your need, desire, or want to monetize your existing business and what that time frame looks like because that IPO window doesn't allow for a full exit, but one that Usually takes 18 or 24 months to fully realize.
The second piece is around geopolitical and just what's happening overseas, and We are just in very early stages of seeing what those shocks may do. I mean, what we're seeing in terms of the Red Sea and potential delays And higher cost on container shipments and what that can do for seasonal businesses, and so we're starting to see commentary come out from CEOs about that and concerns about that. But But what that's also saying is that, again, if you have a business and you're looking to monetize, you've just gone through 3 years of volatility that were all COVID related, and now you see that That, you know, the world continues to be volatile and expect the unexpected, and so that maybe that ideal window may or may not exist and that This is just now the new reality, and so, you know, I think that, you know, we've talked about normalization coming out of COVID, and I think normalization is that Interest rates are higher.
The consumer is doing what the consumer is doing. Global affairs, you know, there's, two significant wars that are happening abroad that are certainly capturing a lot of media, and so, you know, I think the question is really, how do I navigate this environment, how do I invest in this environment, and how do I exit this environment.
Vito
Gentlemen, I think it's been a great conversation today talking about the consumer and retail landscape and and what we're seeing, and certainly, From your comments, from your recent conversations with clients, and the positives that we heard about the Q4 of last year for their businesses, It does feel like the environment, you know, macroeconomic environment, their own business environment, feels like it's gonna be a positive impact on sentiment going forward, both for the consumer and for the CEOs and boards that are running these companies, and so as a result, you know, I think we all feel like there's gonna be an uptick in consumer and retail, and one, and there's a lot of factors there. Certainly, there's some continued headwinds, which we've talked about. But I think we're seeing a lot of that activity right now in our own pipeline, and I think it's gonna continue on a go forward basis. So, Larry, Douglas, Hugh, thank you for the engaging conversation today, and look forward to our next conversation.
Larry
A pleasure chatting with all of you.
Douglas
Appreciate it. Thank you.
Hugh
Everyone.
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