Listen: The Pipeline: M&A and IPO Insights | Ep. 1 - It's A Buyers' M&A market, But Not All Sellers Got The Memo

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Joe Mantone

Welcome to The Pipeline, a podcast from S&P Global Market Intelligence that will be dedicated to all things deal-making. On this podcast, we'll be leveraging Market Intelligence's data, resources and industry contacts to examine mergers and acquisitions, IPOs and other equity offerings. And we'll also even dabble a bit into the debt markets. I'm Joe Mantone, your host, and I currently lead our U.S. Financial Institutions coverage for S&P Global Market Intelligence.

I have also been following investment banking trends for about 15 years now. For this first episode, we'll be hearing some firms that are huge players in the deal-making landscape, and we'll get their takes on the outlook for M&A in 2023. The commentary comes from December's S&P Global Market Intelligence's M&A In Focus webinar.

During the event, dealmakers from Blackstone, JPMorgan, PwC discuss the state of M&A and their outlook for 2023. We also heard from the Chief U.S. Economist at S&P Global Ratings, who provided some comments about what ratings is seeing in the market. Before we hear from them, I wanted to go over some M&A numbers to help set the stage for the discussion.

The total value of global M&A fell sharply about 36% in 2022 compared to 2021 according to Market Intelligence data. The drop was large, but 2021 was a historic record-setting year for M&A., so it wasn't too surprising that we saw a drop off.

However, the interest rates and lower equity prices that we saw in 2022 certainly put a damper on M&A activity. One question that is on the minds of many is whether higher interest rates will force some companies into distressed selling situations. And this was a topic that was discussed during the webinar.

Beth Ann Bovino, the Chief U.S. Economist at S&P Global Ratings said that many companies with investment-grade rated bonds have locked in lower rates for longer durations. But those with lower-rated bonds, such as speculative grades, tend to have floating rates. And those companies feel really more pressure as their cost of financing increases with interest rates.

Beth Ann Bovino

Where's the pain? Well, it's in health care, consumer products, high tech and media and entertainment, were most offloading debts -- or floating debt-rated bonds. That's where the pain we're starting to see already has been played out in markets.

Joe Mantone

That pressure can lead to buying opportunities, especially for companies with strong balance sheets and those who are in businesses that are performing well. Chris Ventresca is JPMorgan's Global Chairman of Investment Banking and M&A, and he said, the level of strategic dialogue amongst prospective buyers is really high right now.

He said that companies are considering acquisitions that can help boost their businesses in the long term. Now can prove to be a good time to make one of these types of deals because many of their favorite targets are trading at multiples that are lower than they were just a few months ago.

Chris Ventresca

There is a large buyer universe and dialogue that we're having with that mindset. The issue is, is at a time where you want to add incremental debt or take on extra leverage or even liquidity given all the uncertainty about the economic outlook, risk of the recession and otherwise?

So what's happening is, while you may feel conviction of, yes, this is an asset you want, you're nervous about taking on leverage, a ratings grade adding on too much debt because a lot of these deals may require cash at the acquisition currency. So you're pausing and watching and selectively announcing deals.

You're also then shying away from the larger deals, things that are 1/3 or half of your market cap, that may require that extra amount of leverage that moves your balance sheet from very strong to less strong. So you're siphoning and filtering out those bigger deals and ultimately looking at smaller deals that are more comfortable, that you can afford to pay, within your ratings, within your balance sheet size and liquidity.

So the type of deals being announced are tending to be smaller size, taking them all by surprise. Again, equity markets are such that companies that would like to use their equity as part of the acquisition currency to get deals done to preserve the balance sheet strength are sometimes doing that, but also not maybe happy with where the stock price is.

So they're not as willing to use their own stock as a currency right now because they feel it's undervalued. So because of all those dynamics, there's a hungry appetite in the buyer universe to try to get deals done, but then they're pausing and waiting given all this uncertainty not wanting to take undue risk until there's greater clarity.

Joe Mantone

If publicly traded companies are worried about issuing shares at current levels to help fund deals that can create opportunities for private equity firms to swoop in and make acquisitions, James Socas of Blackstone spoke about this.

James Socas

As people worry about their stock price and are feeling less good about using that as currency, and you'll see private equity firms with a valuation shift start to step in as some firms already have, as valuations come down. And they see that as a real buying opportunity for the long term.

Joe Mantone

Of course, private equity players have their own financing challenges as higher interest rates and disruption in the credit markets have made attaining leveraged loans more difficult. Some PE shops have stepped in to fill the void and are offering equity and debt solutions themselves.

This not only helps facilitate deals, but it also allows private equity, which is still sitting on a mountain of dry powder, other options to put money to work. Blackstone's James Socas said his firm is one that is offering alternative sources of funding to buyers in prospective M&A deals.

James Socas

People still want to do transactions, and so we've been working both on our own behalf, that was a big part of the Emerson story, but also on behalf of other firms that we work with in being a capital provider in helping get deals done. And we've done that both on the debt side -- private debt side.

And we've done that on the structured equity or preferred equity side as well. So trying to help bridge the gap. Someone wants to do an M&A deal or a private equity firm wants to take a company private, how can we help fund that check size.

Joe Mantone

But what's clear is buyers are ready to pounce if they can get the financing they like and strike deals at lower multiples. Sellers, on the other hand, are more hesitant to accept the current valuations. This is leading to debates inside the boardrooms of potential targets.

Many of those considering sales are companies that see economic headwinds pushing against their businesses over the next 3 to 5 years. JPMorgan's, Chris Ventresca said, this has them asking if they should sell now and take whatever opinion they can get or continue trying to make it through the difficult operating environment. Here's Chris Ventresca again.

Chris Ventresca

We're trying to assess, hey, if I could sell the company for 20%, 30%, 40% premium, give that cash to my shareholders in 3 months in an M&A deal, is that a better risk/reward alternative than grinding out this business plan with those headwinds? Like what's the right answer on behalf of shareholders? And those are real debates happening in the boardroom.

And you've actually seen this year those boards, some of them decide, you know what, getting that premium, even at a lower stock price, but a premium above where it's trading may be the right answer. So you've seen deals announced, a variety of go-private deals across different sectors during the year with that type of mentality.

And those boards have chosen that, that was the right answer for their shareholders and are marking on that basis. But you'll have other targets that are saying, listen, even if I get a quote "market premium," I think I could do better. I think I could execute my business plan. And maybe not get back to my all-time high stock price or my 52-week high stock price, but do better, especially for those companies that have had larger corrections.

So if their balance sheets are strong enough, if they're able to just run their business plan without distress, they're decided to just put their head down and execute on their own the things within their control and not be kind of a for-sale type company right now. And that's why the sell side, again, is a bit stagnant because there aren't that many active sellers in the market, given most of them aren't that unhappy with where the stock price is and think they could do better.

Joe Mantone

Even if buyers and sellers can agree on pricing, another obstacle in today's M&A market is regulatory approval. Closing a deal is not always a certainty, especially in the U.S., where the Biden administration has made antitrust enforcement a priority. JPMorgan's Chris Ventresca.

Chris Ventresca

I think there is a lot of dialogue happening around regulatory approval in every deal that happens now. Pre-announcement, companies are realizing that there's no longer a sure thing that if I announce a deal, it's going to close. There's -- no matter how much analysis you try to do, there's still some uncertainty. And deals are taking longer. I think we have looked at the average deal announcement to close across all deal types is like 3, 3.5 months.

Now it's 4.5 months or so. And then there is a long list of deals that take over a year to close. And some that go over a year and then don't close. We did have a few in the last couple of months in the publishing industry and kind of the chemicals materials industry and others. For various reasons, those deals didn't get approved after a year plus of time between announcement to ultimately that termination.

So if you're a Board or a CEO management team dealing with that, again, either as a buyer or a seller, you have to plan back contingency and do as much work as you can upfront to have as much confidence that if you announce it, you understand the odds that it's going to get to the finish line. Because there's nothing more disruptive than announcing an M&A deal that ultimately doesn't happen 6 months or 12 months later.

So when you're doing these deals now, you have contingency plans, you're deciding, what if I need to divest assets that I'm buying? How does that affect my purchase price? So you're building in more contingency. I need to retain the employees throughout the whole process. I need to keep investing in the business. Because what if it doesn't happen, this deal. I've got to go back to running my old business plan.

So if a year goes by, you'll just have to keep investing and keeping people and retaining. So there's a lot more analysis. Ultimately, that is a risk-reward trade-off that company that decide. Is the deal worth it? Is that risk worth it? Like creating so much value that it's worth attempting it, but I'm going to have to have these contingency plans.

So I'd say it factors into every M&A deal certainly within -- that's why the private equity community somewhat has an advantage. To James, in that industry as a private equity buyer, which maybe doesn't have an asset in that sector because it's kind of a focused fund, one acquirer, so to speak, that is an advantage to maybe get to a faster regulatory approval than that strategic buyer that is in the same industry, that may have that multi-month regulatory review.

And Boards can then put that in their decision-making about what price they're willing to take to understand the risk-reward trade-off of that acquirer on the sell side. Would I consider a lower price for a more certain deal versus the higher price for a riskier deal? We have seen boards have that debate, and some take the lower price for more certainty.

So short answer is, it is a concern. It factors into every deal discussion we're having. And it does impact how you go forward and what you decide to pay. Because companies are building in contingencies for divestitures or other things to get the deal.

Joe Mantone

If there's a silver lining to the long regulatory approval process, it's the fact that the companies who are combining have plenty of time to get their integration planning in order. PwC's John Potter said that this extra time to plan can help them hit the ground running once the deal does eventually close.

John Potter

Well, I think the first thing I'll highlight with that is the timing point. And that delay in the ability to close, it provides an opportunity, if you have the confidence on the ultimate approval to actually move forward quickly on the value-creation plans. And so while the delay is dilutive in value at the onset, it does allow the acceleration of the ultimate -- I'll call it, the transformation comes with the deal.

So that's one thing we are seeing is, while recognizing the risk-reward trade-offs that Chris mentioned exists, those with the confidence that they ultimately will get that approval are moving with more speed to move with that business once it does close.

Joe Mantone

In whatever type of investing you're doing, identifying opportunities is just one step. Execution after the investment is extremely important, and it becomes even more important these days in M&A, given that the math has changed in acquisitions and financing is more expensive. John Potter for PwC mentioned these challenges.

John Potter

Because companies will do deals when it is key to their current near-term and medium-term growth. And the key is just to do deals well. Higher cost of capital, other dynamics, it's really going to come down to how do they execute those deals and the discipline to drive the returns on those investments in the near term.

Joe Mantone

Some of the most challenging transactions execute are cross-border deals. Given the difficult operating environment and deal-making conditions, it's no surprise that cross-border deals are down. JPMorgan's, Chris Ventresca said cross-border deals typically make up 30% to 35% of deals, but that number has been closer to 25% of late.

Chris Ventresca

I think in this time of uncertainty, which is not just U.S. uncertainty, but clearly, global economic uncertainty as well as geopolitical risk depending on regions, there's a lot of companies that are just putting their head down, focused on their business in their own home market and planning ahead on that basis as opposed to lifting their head up and thinking about M&A deals outside their home markets.

Joe Mantone

Of the cross-border deals that are taking place, many of the buyers are U.S. companies, Ventresca said.

Chris Ventresca

It kind of makes sense. A lot of the U.S. companies have probably been and have been a little healthier, a little stronger balance sheets. Still generating good cash flow, have that willingness and confidence to make that cross-border acquisition. I think the strengthening U.S. dollar has also helped some of that calculus for those companies looking at using financing. Either again, home-based currencies or the use of the dollar to finance some of these non-dollar-based assets overseas or trading on exchanges overseas.

Joe Mantone

Ventresca does expect foreign buyers to increase their interest in U.S. targets during 2023. He said the U.S. market is just too compelling for companies that are looking to enter.

Chris Ventresca

And if you're not in the U.S. market, you want to have a plan to be. Because generally, the longer-term growth rates, the consumer base, the assets in-place or access to technology, there's a lot of tailwinds that you may find in the end market, if you're not here, that you want to get in.

And a lot of our clients globally think that way and are finding ways to enter the U.S. market, either organically or inorganically through M&A. So I think, again, as economies stabilize, stock price volatility hopefully narrows, you will see more balance, where foreign acquirers of U.S. assets will happen -- that will pick up as we move into '23.

Joe Mantone

Another potential driver to M&A is technology. Technology has been a catalyst for cross-sector M&A in recent years as companies in various industries have been making acquisitions, adding tech in an effort to enhance their offerings. PwC's John Potter expects to see more of this in 2023.

John Potter

If you look at the major industrials, they continue to focus on digitalization and modernization in their transformation and technologies. At the hub of that, consumer markets clearly focusing on the customer experience and digital agenda. And then even in the financial services sector, we still see consolidation, and the technology agenda raising high up. It's going to lead to much of that activity.

Now the tech-within-tech dealmaking will continue. But again, I think it's that cross-sector investments we see industries converge that really will create some of the more interesting activity. And again, it's part of that overall transformation that businesses are trying to achieve in these times of different economic factors.

Joe Mantone

For the innovators that don't want to sell just yet, finding funding sources has been a challenge of late. Even the more mature companies that are ready to go public don't really have much of an option because the IPO activity has been extremely slow in 2022. And that's expected to continue in the early part of 2023. Both of these situations are creating opportunities for Blackstone, Socas said.

James Socas

We're still big believers in the global economy. We're going to get through kind of the current shock that we're in. We think there are some incredible innovation cycles going on right now. And there are some very, very interesting growth companies out there. So we're actively looking at growth funding.

Right now, the valuations on those rounds might have changed a little bit, but we're very active on the growth side, kind of straight equity checks -- preferred equity checks into growing businesses and tailwinds industries. And then the final area where we've been spending a lot of time is with the IPO markets resetting and potentially getting pushed off for who knows when, they'll reopen.

There are some terrific companies that are now at $150 million, $200 million, $250 million of revenue that are looking to bridge that gap to when those markets might reopen. And we have been and other firms have been looking at ways to provide pre-IPO funding that helps the firm get -- helps the company get a great firm in their book and supporting them and adding value. But also helps them kind of weather whatever period we're in before the IPO markets reopen.

Joe Mantone

It's no surprise that firms like Blackstone are looking for different ways to put money to work, given the difficult deal-making conditions. We will continue to follow those and other trends throughout 2023 here on The Pipeline podcast. But that will do it for our first edition. I'm Joe Mantone with S&P Global Market Intelligence, and thanks for listening.