The Pipeline: M&A and IPO Insights | S.4 Ep. 3 - Dealing In An Uncertain M&A Environment

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Joe Mantone   00:00:00

Welcome to another episode of the pipeline, an S&P Global Market Intelligence podcast that dives deep into the world of M&A and IPOs. I'm your host, Joe Mantone. And today, I will speak with Kevin Desai. Kevin is the U.S. and Mexico deal team leader at PwC. And before his current role, Kevin was the private equity leader at PwC. So leading deals for U.S. and Mexico and then private equity before that, that's a pretty broad spectrum that I'm sure it keeps you pretty busy. Kevin?

Kevin Desai   00:00:41

Joe, first, thanks for having me as your guest today. I'm really honored to be here. And you're right, I think with the various mandates through my career in the current role was that our U.S. deals leader does keep me quite busy. It's a very dynamic market right now. So responding to the ever-changing landscape keeps us on our toes.

Joe Mantone   00:01:00

Great. Yes. And I think having that broad background makes you a really good guess for today's episode, which will focus on the current market volatility and how it's impacting M&A. For all of March, the VIX Index, which looks at the volatility in the S&P 500, that's pretty elevated, mostly because of the Iran war. But even before that, we were seeing some volatility tied to concerns with the private credit market. Both of those areas, I think that it doesn't affect every company directly, but just about everyone is indirectly affected. Kevin, given your team covers a wide area. I'm interested to hear how -- what you have to say about the volatility and the impact on dealmaking. But -- before we get into that, I always like to learn a little bit about people's backgrounds and how they got into the industry. And Kevin, I see you went to the University of Illinois, you studied accounting. And then after that, you climbed the ranks at PwC in Chicago. So has your career followed the path that you expected?

Kevin Desai   00:02:04

Joe, in some ways, absolutely. In some ways, it's a little bit of a roller coaster and a very nonlinear path. But you're right, I went to Illinois. I got a very good foundational education and accounting and finance, and I joined PwC right out of school, and I really didn't leave. And I think that's the part that probably most people don't expect after 22 years at one organization that you're still there. But the foundation I learned early in my career, the mentorship that I've received along the way, the opportunities to help solve really large challenges for clients over the last few years has really been keeping me engaged, but mostly, it's the opportunities that the team presented me and the mentorship that I received and the friendships that I've built that you don't really think about when you're '21 leaving school. And you find yourself here a little bit older in life and feeling pretty good about how things are going. So just keep on keeping on.

Joe Mantone   00:03:06

Yes, that certainly makes sense. build those connections and build a strong relationship with your team, and I'm sure that really helps with the advice that you give clients. Given the time that you've spent at PwC, I thought you'd be in a good position to explain the work that PwC does on deals. It's my understanding is there's a couple of different divisions. The corporate finance team operates more like a traditional investment bank, while the deal advisory team does work around ensuring earnings numbers and other multiples are accurate and also providing some post-deal support. Is that close to being right in describing the work that your teams do?

Kevin Desai   00:03:44

So, I think that's a pretty fair synopsis. You're right. Our corporate finance team is a middle market investment bank. And around the globe, we're probably on top of many league tables from the size and scale. It's a part of our business globally that people don't usually associate with the brand. Obviously, our brand is really strong on the pre-deal space starting with commercial strategy, diligence, all the functional diligence, whether it's finance, HR, IT, tax, et cetera. And then the post-deal value creation, whether that's through synergies or integration or the subsequent divestitures and IPOs, our team is built to help clients negotiate or navigate all aspects of the deal life cycle.

Joe Mantone   00:04:28

So the corporate finance, the middle market investment bank is focused on the middle market. So does the advisory team, is that on a wider swath of companies?

Kevin Desai   00:04:39

No, that's absolutely our broader advisory team. And our investment bank also can go up and down the spectrum, but that's where they hit hotspots. And our broader advisory team helps from the lower middle market to the bulge bracket, blue chips, the large cap businesses everywhere in between.

Joe Mantone   00:04:58

Great. Yes, that's perfect. Yes, because definitely, I think what we've been seeing in recent years is large deals have been driving the market. It's been boosting deal values, but we haven't really seen as many middle market transactions. So it would be good to get your perspective on both those. And getting into the M&A environment, based on the numbers I'm seeing, there appears to have been a bit of a slowdown in March for M&A, especially in Europe and Asia. Is that what you're seeing? Have you noticed any drop in activity at all either in the U.S. or Mexico or other parts of the world?

Kevin Desai   00:05:35

Absolutely. When we look at '24 to '25 as our baseline and the growth you said that we saw, I think you called it out. A lot of it was at the top end of the market, really in the mega deal side. That has -- that persisted in January. The number of mega deals that came through in January were still quite strong. But actually, March announcements are down, right? We don't see as much in March actually to date, when I last looked, and this was maybe a week ago, we only had 1 mega deal. But in February, we had 10 announced. So you can say we're almost halfway through the month. There's only one mega deal so far. It feels like there's a little bit of a pause on that. And we can dig into why that might be. I think there's a lot of reasons. But -- and then when we look at the middle market size, which is really where the volume of transactions are, right? So if you're thinking on average, there's somewhere between 10,000 and 12,000 deals in the United States that are announced every year. And we're -- a few hundred of those are mega deals that drive tremendous amounts of value through the ecosystem. The volume is still powered by the middle market. And the middle market hasn't really recovered in 2025 despite the top end of the market growing tremendously to all-time highs and at least in the last 5, 6 years from an all-time high perspective. Middle market volume, depending on how you -- what data sources you look at, it's somewhere between flat to up 2%. And we're not really seeing a change in that trajectory in 2026. I think we were hopeful at the beginning of the year that there will be some unlock because of some macroeconomic factors have been -- that were breaking the way of the U.S. economy. But while the economy is resilient, there's obviously been some changes in the world these days, and that has caused a little bit of a pause. To get to your specific question on Asia, I think it's a fair statement to say that in Asia Pacific, things have been a little bit choppier, a little bit more uneven relative to other regions, specifically because we think cross-border processes tend to feel the friction first. When there is a little bit of uncertainty, you have to think about where they're moving, how money and capital will flow seamlessly across borders. I also think with some of the movement in oil prices and some of the sovereign wealth funds that power a lot of cross-border activity are retrenching a little bit just as things stabilize with oil prices...

Joe Mantone   00:08:11

Sure. That makes sense. And just to make sure that we're on the same page here. When you say mega deals, what size deals are you talking about? And the middle market, like how do you -- what do you -- what size of companies do you think about when you think about?

Kevin Desai   00:08:22

That's a really good question because I think everybody defines it a little bit differently. But from a mega deal perspective, we generally track $5 billion higher as a mega deal and middle market is everything below that to the few hundred million dollars, if you will.

Joe Mantone   00:08:39

Got you. So the middle market, you said we're seeing a little bit of a pickup there, but not a huge pickup year-over-year in the number of deals? That's correct. And then on the mega deals, $5 billion and bigger, we've seen a bit of a slowdown in March. So do you think it's tie it to the volatility from the Iran war, the drop in mega deals so far in March? Or is it too early to tell?

Kevin Desai   00:09:02

I think it's a little early to tell. And I think there's a few things, but I can dive into the ins and outs of this. One, March is a particularly difficult month to announce something large with the earnings season right around the corner. So usually, maybe towards the end of March or early April, there's a pickup in announcements just given we want to make a splash or clients might want to make a splash right before earnings releases. So I think that is something to think about. I think in general, some of the conflict and the resulting oil supply shock, it's one of the largest supply shocks and disruptions recorded on history. And despite these large coordinated releases of reserves and the interest to protect the continuity of supply, there's a little bit of uncertainty that is growing in the market. And you can see it with the overall recession risk indicators, right? If you look at consensus estimates from economists about what would happen and what is the probability of a recession in 2026. Prior to the conflict, it was below 25%. After the conflict, you currently today, it's closer to 30%, 35% risk. So again, less than 50%, which should make us all feel good as investors, but directionally headed in the wrong way. And where that really comes to bear then is on interest rates. Prior to this, where there was a little bit more stability, the risk of recession was tame. -- the likelihood was that there would be 2 cuts or more in 2026, and that was an 81% probability. That is now down to a 21% probability. So the financing environment with the supply environment and the recession risk environment, it all starts compounding a little bit to suggest that which way is the economy going to go and what's the financing market going to be. And so that's what we're feeling day-to-day when we speak to our clients about, are we going to pull the trigger and announce something big. There's some concern that is mounting. That said, I think if a deal is highly strategic and highly accretive and synergistic, there's no time really like the present to get going, and we can talk about that a little bit more.

Joe Mantone   00:11:30

That's interesting. So it's more -- the pause right now, you would say it's more tied to concern about the interest rates as opposed to market volatility and like price bid-ask matching.

Kevin Desai   00:11:42

Yes. I think they're all interlinked, right? The bid-ask becomes wider when there is more volatility. And as interest rates -- the price of a deal will move as interest rates move, right? If you think about multiples being a factor of your cost of capital and your growth rates, as your cost of capital keeps moving, enterprise value of a business that based on an EBITDA multiple should move.

Joe Mantone   00:12:04

That makes sense. Yes. So it just adds uncertainty and that always gives a little bit of pause. It could really just be prudent to put some deal discussions on hold right now, right?

Kevin Desai   00:12:14

Could be, right? I think you have to really look at the resiliency. We're going to come back to talk about resiliency of supply chain. We saw this a few years ago when there was trouble in the Red Sea from a shipping perspective, the supply chain disruption and how that leaked into the deal market was real. And now we're in a similar situation where shipping lanes are closing and things are a little bit difficult to move. That does increase volatility and it causes some issues with should we pull the trigger. That said, and I'll reiterate it, it's like if there is a strategic reality here, if a deal is truly tied to a transformation or something to deal with your competitiveness in the market, waiting for the perfect environment can be -- can mean you're going to miss the window, right? The regulatory landscape is moving. The commercial landscape is moving pretty quick. Competition is moving quick. So waiting for something perfect to time it is not ideal if you're a large corporate buyer who's trying to pivot the business.

Joe Mantone   00:13:18

Yes. That certainly makes sense. Are there some sectors that might even be more immune to the current volatility? I know health care has been a focus for you in the past. So might that be an example of a sector that could be a little bit more insulated from the recent volatility that we've seen?

Kevin Desai   00:13:38

I think definitely, as you think from a geopolitical perspective, health care will -- obviously, is a local business. And you saw it in the most recent job reports that really health care jobs are growing at a nice clip and fueling job growth in the U.S. And so you're like, okay, the tailwinds behind health care remain real. You have an aging population, you have to look for cost and efficiency. There's a lot of growth. But what we're still seeing is there's quite a bit of reimbursement uncertainty and regulatory uncertainty coming out of the one big beautiful bill. Some of the rural health care initiatives are helping stem that, but it becomes a regulatory policy issue that drives different type of uncertainty than the macroeconomic geopolitical uncertainty that why we're not seeing a real pickup in health care activity. What we are seeing in health care, though, is especially on the private equity side, folks realizing that health care is here to stay in the U.S. It is a little bit immune for some of these system shocks that we've been talking about so far. So how do I play in those themes without taking direct provision of care risk. So things such as health care IT or workflow management or staffing or things around the health care ecosystem remain quite popular investment thesis. And that is a long-winded answer to say, yes, every industry is being affected slightly different. It's interesting as talking to my fellow deals partners and all of a sudden, it feels like industrial products are back in vote. And because -- and a little bit different, despite some of the supply chain challenges, you think about the large disruption in enterprise software that we're feeling with AI or maybe the uncertainty because I do think enterprise software still is a good investment theme if you're thinking about the right type of businesses. But between enterprise software being hindered by AI, professional and business services, they have a lot of question marks now in the age where technology is advancing as fast as it is, companies that build strong products with a good market position that would be maybe a little less glamorous last year are safe or bad today. And at least that's what we're hearing and seeing in the market.

Joe Mantone   00:15:59

Okay. Yes, that's interesting. Any other sectors where you think you'll be seeing a pickup in activity?

Kevin Desai   00:16:04

We still continue to see quite a bit of focus on payments within financial services, the payment sector, fintech and insurtech and brokerages. So financial services remain strong as well.

Joe Mantone   00:16:18

Yes, that's definitely an area where we've seen some rollback in regulation opposite of the health care area. So I can see how that could spur more activity.

Kevin Desai   00:16:26

That's right.

Joe Mantone   00:16:27

And thinking about your point that you're making earlier a little bit more about if a deal makes sense, it still makes sense, and you should probably pursue it if that strategic fit is right. I would think that businesses with stronger balance sheets and cash reserves on hand, they're more likely to -- in a better position to pull off a deal in a volatile market.

Kevin Desai   00:16:47

Yes. I think businesses that are well capitalized and have flexibility in their balance sheet allows them to move in times and worry a little bit less about exactly fine-tuning the capital structure and what the exact interest rate is that you're going to be borrowing at, whether it's plus or minus 25 or 50 basis points. And really, I think what we're finding is those well-capitalized businesses have just strong market fundamentals, right, with strong cash flow generation profiles, which tells us something about their business and their ability to get after a market moment. So I would agree with your statement.

Joe Mantone   00:17:23

Okay. Yes. And then from a seller's perspective, do you think we might see more companies looking to divest businesses that they might not deem as core in this type of market?

Kevin Desai   00:17:38

Absolutely. I think in times of change and uncertainty that we're in, whether it's technological change driven by AI, energy, et cetera, or it's just general market uncertainty, companies need flexibility to invest behind portions of the business to continue to pivot, innovate and drive those businesses. it's hard for businesses that have a very wide portfolio of products, services, customer bases, markets that they attack to innovate consistently across the portfolio. So in times like these, we often preach to our clients, we should take a look at the portfolio and see where are you actually the best owner of all the assets that are in your portfolio versus where is there some hidden value. And if there's some hidden value, let's find a way to unlock it. And then obviously, that divestiture plays a role into that. And then how do we redeploy the capital that's freed up from the divestiture into fueling the growth of the places -- the 1 or 2 places of the business where you want to double down or pivot the business. So right now, we do see divestiture volume staying relatively strong and carve-outs picking up in general. So we believe our clients are actioning on this strategy.

Joe Mantone   00:18:55

Yes. And that's been a theme over the last couple of years, right?

Kevin Desai   00:18:59

Yes. I think portfolio realignment largely driven by the technological change and the business change, and it started before AI, right? The U.S. economy continues to pivot from a goods economy to a services economy. A lot of goods businesses are trying to become subscription-based businesses, a lot of in historical health care or financial services businesses are moving and more -- looking more like health care IT businesses or fintech businesses. And those strategic pivots require capital and require decisions to be made about where are you doubling down on which markets and capabilities, which will leave certain parts of the portfolio stranded. And so rather than letting something die on the line and be undervalued by the market, it's better to unlock value for shareholders of divest noncore assets.

Joe Mantone   00:19:53

Yes, it seems like it shifts a little bit that investor sentiment sometimes investors are -- they do want that broad diversification, but other times, they want you to focus on the core business, but it seems like focusing on the core is the current trend.

Kevin Desai   00:20:07

I would agree. I think it's interesting because the different financing environments allow you to take different strategies. When financing was a little bit cheaper, you could raise capital to pursue many options, right? But when financing is a little bit more expensive, you have to be prudent about where the capital comes from and how it's deployed and the required rate of return on different investments for your shareholders. So then you start coming into a little bit more focus on the maybe the 2, 3, 4, 5 bets you want to make instead of the 6 through 10 bets...

Joe Mantone   00:20:42

Yes, that's a really good point on interest rates there, for sure. Thinking about the current volatility a little bit. I was thinking about sellers who might have been doing their prep work and been getting their due diligence done and all of a sudden, we get hit with this volatility. What's the advice for those clients?

Kevin Desai   00:20:59

I think the interesting part is that prep work doesn't mean you have to sell. Prep work means you're ready to hit the window when the window is right for you to hit. And oftentimes, what we're talking to clients about is, okay, let's do the prep, let's understand, let's see what the go-forward strategy of the business could be for carving out of business and moving on to it. If the window isn't right, the question is what can you do to operationally improve the business and start to operate it a little bit on a stand-alone basis to make it more attractive for a buyer in the near term. So like our focus has been with our clients is if an asset is noncore, it remains noncore. And so the -- we should be very intentional about identifying, separating, managing those businesses separately to make them attractive and so you can hit the window when the window is right to walk.

Joe Mantone   00:21:57

If you are trying to sell, you're trying to balance -- valuations have come down with also not trying to look like a for seller. I'm sure that those are some things that we're trying to think about if you're looking to run a process at this point.

Kevin Desai   00:22:11

No, I think that's right. I think cleaning to old valuations is dangerous because you've got this anchoring heuristic out there that's not grounded in reality and if you're a Board member or you're an executive, I deserve to get paid x for this assets, you may have at one point, but the market is booming. And this is -- I mentioned this earlier about being strategic about when it's really strategic, don't wait for something to be perfect, take the opportunity. I think the same is true here. I don't know if I were in my client shoes, I would always say, let's sit back and wait for market pricing to improve. I think the old adage of timing the market is very difficult. So if something is noncore, nonstrategic, let's reduce the burden and let's reduce the scatter of focus of the management team. Let's make sure the management team can be focused. Let's move on and pursue the strategy to the extent that you still have to be responsible with shareholders money. So you can't -- to your point, you don't want to be in this position where it's perceived fire sale by any means, but you do want to move on and redeploy capital in a more efficient manner. So if you can return capital, maybe it's not exactly what you had in mind. But if it enables you to enact your strategy, the next step of your strategy a little bit faster, where the net benefit to the shareholders be greater by moving faster on the new strategy, which is unlocked by pushing through on the sale process.

Joe Mantone   00:23:44

Sure. And if you're a seller, what are some steps that can be taken to try to make yourself a little bit happier with the valuation? Is it maybe attaching some more earn-outs to deals?

Kevin Desai   00:23:57

Yes. I think the 2 things that we continue to see is like earn-outs are -- remain a popular mechanism for folks to say, okay, you may not believe my equity story that I'm selling you. So I will sign up for an earn-out and as the business proves what I'm -- the forecast I put in front, please pay me for the return that you're getting. I think that is a fair tried and tested way to get incremental valuation that is balanced from both the buyer and the seller. I think the other thing that we continue to see is stake sales. Okay, fine. I can't get the full valuation I want today. So rather than selling the whole business, I will seed control of the business to the new buyer, but I will participate in the upside by retaining somewhere between 10% and 40% of the equity of the new company. And so those allow you to, again, return capital a little bit faster, but -- and reinvest in your core business as you decide but participate in upside that you otherwise were not able to participate in the current market environment if you feel like the pricing is off. So those are the kind of 2 strategies we see most frequently deployed.

Joe Mantone   00:25:11

Sure. Yes, that makes sense. And I want to wrap up here by talking a little bit about private equity and you mentioned returning capital. And I know there's been a little bit of pressure on some private equity firms to exit some of their investments that they've been holding on to. I would imagine the current market just makes it a little bit more difficult for private equity exits. Is that right?

Kevin Desai   00:25:34

I think that's absolutely right. And I think it's tied broader to the broader middle market motions that we see in the market. And the middle market is a little bit more susceptible to being tied to general macroeconomic environment. we see middle market businesses in general thrive and earnings grow and more highly correlated with broad-based U.S. GDP growth than we do in large cap businesses.

Joe Mantone   00:26:02

That's interesting. That's the case. I would have thought it would have been the opposite.

Kevin Desai   00:26:06

No. And so it's interesting. The lower market, the start-ups that are growing super fast, that are innovating and doing things completely different can be divorced from GDP. But if I have a stable middle market business that is a good LBO candidate, right, with stable cash flows, a good market positioning, et cetera, I remain middle market because of the size and the scale. And that usually means I don't have customer diversification or I don't have geographic diversification. And I'm not big enough to create my own future, if you will, or to buck the trend. So there is a little bit more of all rising tides lift all boats in the middle market. And I feel like that is a little bit of what we're seeing in the middle market. And it's actually what made us more bullish about the middle market in January. And not to say that we are -- that we don't believe the resurgence will come. It's probably just a little bit down the road with a little bit of the uncertainty that's hitting the U.S. GDP estimates. But effectively, as the labor market stays strong, if GDP stays strong and growing and we can diversify earnings away from the large cap to the broader middle cap, I think at one point in January, the Russell 2000 earnings were outstripping the S&P, which is why S&P 500, which is why we were feeling good about a middle market resurgence. We're hoping that kind of returns. But -- so if you think about where the large volume of private equity investments sit, it sits square in that middle market. So if I'm an investor in private equity, I'm hoping for that middle market resurgence. So I don't have to take a valuation haircut because I think the valuations are returning because the economy does remain strong currently.

Joe Mantone   00:28:00

Right. So elongation to the hold times, do you think we'll see some of that come down?

Kevin Desai   00:28:06

I think it will take time for the hold times to come down just given the backlog. But I am hopeful that in the -- as we enter Q2 and into the summer period, we'll see an unlock here of more of the middle market deals. There is just private equity has to move on from some of the investments that they've made. So there will be this moment where we'll just have to happen. But until then, I do think barring what happens with the geopolitical environment and interest rates and oil and all that, if we put that uncertainty aside, the U.S. economy is humming. So as it continues to home, that should power the middle market, but I just gave you 3 or 4 meaningful caveats. I think we have to see how the situations unfold.

Joe Mantone   00:28:51

Yes. We'll certainly be watching. And thank you for taking all this time here to walk us through what's going on in the market and going over all. So thanks a lot for your time today, Kevin.

Kevin Desai   00:29:01

Absolutely, Joe. It's a pleasure to be here with you today. Thanks for inviting me to be your guests.

Joe Mantone   00:29:07

That will do it. For this episode of the pipeline, we thank Kevin Desai of PwC for joining us, and we thank you for listening.