A review of the worldwide marketplace (2023)

Nicola Charlston 
King & Wood Mallesons, Melbourne
nicola.charlston@au.kwm.com

Report on a session at the 20th Annual International Mergers & Acquisitions Conference in New York

6 June 2023

Session chair

Mark Pflug Simpson Thacher & Bartlett, New York

Speakers

Kenneth Jacobs Lazard, New York

Leslie Picker CNBC, New York

Anirban Sen Reuters, New York

Lauren Thomas The Wall Street Journal, New York

Historical perspectives

Kenneth Jacobs started the session by giving his views on the historical perspectives that have led the M&A market to where it is today. He observed that M&A is a highly cyclical business; 60 per cent of deals close in the first six months (larger deals take longer, while smaller deals are shorter). There is significant volume fluctuation, and while the business over the long term grows around 3–4 per cent, it can have big ups and downs over the cycle.

Key issues that have led to the current downturn

Jacobs observed that the following key factors have led to the current downturn in M&A:

• availability of financing (which is at its most expensive since the global financial crisis);
• valuations (equity valuations reasonable on a current basis, but there is a gap in buyer/seller expectations); and
• boardroom/chief executive officer (CEO) confidence (decision-makers need confidence in their ability to predict the future – this is very difficult at the moment as there is no consensus, and this stifles M&A activity).

Lauren Thomas asked Jacobs to expand on the point around CEO and boardroom confidence; she asked what the current conversations in the boardroom are. Jacobs’ experience was that boards were focused on:

• ‘If I want to do something, can I get it done?’ (Regulatory issues apply to 10–20 per cent of deals). The regulatory environment is more challenging today than it has been in a long time – the way regulators are using their powers has changed;
• Uncertainty factor: if a company is non-investment grade, access to financing is much more limited and expensive; and
• Confidence in the ability to predict the future – this is key, as noted above.

Anirban Sen raised the complexities of advising clients in this environment. On the sell side, certainty of closing and pricing are important (ie, whether price expectation can be fulfilled); the expectations of sellers are beginning to adjust but have not yet fully adjusted. On the buy-side, there is more focus on synergies, getting the deal closed and financing costs – all these decisions are more complicated in the current environment than previously.

Thomas observed that strategics have an edge over sponsors currently; she asked whether that will last. Jacobs thinks that the advantage will last for a while until there is a shake-out in the financing markets for private equity (PE). But regulatory issues can be complicated for strategics where there are overlaps  – and PE has enormous pools of capital that must be put to work.

Role of private credit

Leslie Picker asked Jacobs on his thoughts on the role of private credit, and where he sees the future in that space.

Jacobs sees private capital expanding beyond sponsors to strategics. The vacuum needs to be filled by something – regional and community banks are under material pressure;, the regulatory environment is stricter and margins are shrinking. Private credit can and will fill that gap, and is more flexible than big banks.

He noted that there are two forms of private credit: (1) locked-up capital that comes from big institutions and sovereigns; and (2) the use of insurance balance sheets – these are two very different models. Other observations regarding the regional banking crisis included:

• The US has far too many banks, and needs consolidation. Efficiencies come from scale and you cannot have different levels of regulation without creating risks – the two-to-three-tier US system would never have happened in systemically regulated banks; and
• The M&A downturn preceded the banking crisis. The crisis in regional banks has not had a huge impact on M&A generally, but there has been some contraction of credit.

Catalysts to jump-start M&A

Some potential catalysts to jump-start M&A include:

• Confidence: if financial conditions start to stabilise, the cost of financing becomes more certain – then we may see deal activity picking up at current interest rate levels (the reality is that rate levels are still low when compared to the long-term average). There must also be consensus around equity valuations;
• Other catalysts may include:
  • the spread of tech across every industry;
  • energy transition;
  • artificial intelligence; and
  • bio-pharma.

However, upturns don’t happen in one year (other than in 2021). It generally takes a few years; 2024 will probably be better than 2023, but we will not see the full effects until 2025 or 2026.

How have capital markets conditions impacted deal making?

Jacobs noted that initial public offerings are an alternative for exits; without that, PE is left with recapitalisation, continuation funds or sales to a third party. However, the initial public offering (IPO) markets will reopen at some point.

Regarding special purpose acquisition companies (SPACs), the most recent iteration is dead for now, but someone will come up with another iteration at some point that is more shareholder and disclosure-friendly.

The role of activism

Activism is a vibrant area, and the activist playbook has evolved over time. Activists are suggesting they can run a business better than the existing management and are much more sophisticated now – for example, they are thinking about allocation of capital, M&A and the mix of assets that they own.

Thomas noted that the US had seen more swarming situations (eg, Disney or Salesforce) where multiple activists are in the same stocks – this can be complex for companies where they have multiple hedge funds asking for different things. This is challenging for boards of public companies, as it becomes unclear who is really thinking about the long-term future of a company. Who is responsible for that? Index funds have a long-term interest but activist funds do not. Where there are competing activist demands, boards must think about what’s in the best interests of the company. It may be an exhausting and difficult decision-making process, played out publicly, but in the end, a well-led board with good advice ends up making the right decisions.

Banking industry

Picker asked Jacobs for his observations on the banking industry: Goldman Sachs and Morgan Stanley essentially have the same market share as in 2007; EU banks have gone from a 34 per cent to 10 per cent share; Citibank and Merrill Lynch have gone from 16 per cent to 12 per cent. Independents have gone from 8–9 per cent to 45 per cent today.

There has been movement of talent from the EU banks to independents. Since the global financial crisis, independent banks have done well in the sponsor business. Their core expertise can help, even if not supported by a balance sheet.