The Long-Awaited M&A Comeback

Give us a sense of where we are. I mean you had some record years of merging acquisitions and then it really fell off a Cliff a little bit. How far back are we look, I think you need to look at this as pre COVID and post COVID because of the disruptions of the COVID period extraordinary. And the reality is almost every market is healing and is reaching higher highs other than the M and A market. So we're seeing investment grade debt issuance, record levels, spreads as low as they've ever been. In a similar vein on the equity side, equity issuance now is ahead of where it was pre COVID. So all of the necessary conditions are in place and notwithstanding all of the desire to transact and to get ahead of a changing economy, M&A volumes continue to to be to be soft. So explore the other than part of that why is it other than why is M&A lagging behind the other markets. Well, I think it's a couple of things. One is the current view on antitrust is clearly having a chilling effect on some deals. So we see many deals being contested. You're seeing the FTC and the DOJ being very vigilant and they're antitrust enforcement, lots of second requests, elongated periods between announcements and Closings. And it's not just those deals that get reviewed. There's a self editing process and we're seeing a lot of deals that are debated vigorously in boardrooms. They never see the light of day because companies are uncomfortable putting themselves through that extended review process. That is one of the big issues. And I think the second one is private equity, which is such an engine of M&A activity. They've not been, you know, on the front legs the way they were historically. And I think a lot of that has to do with interest rates. On the first issue about regulation, do boards ever get sort of used to it, as it were? Because although there was a lot of challenges, not too many have been successful, as I recall. Says somewhere they say, OK, yeah, they'll challenge, but in fact we'll get it through the the batting average of the government has not been very high, but what it has done is it sent a signal that for many deals, even if there's no underlying reason why the transaction should not be approved, you're going to end up with an extended review process and review processes that get elongated. They bring risk and the more risk there is, question becomes how does the business perform during what could be of 1215, even 18 months between signing and closing. That's a lot of risk that a buyer is underwriting and I think there are a lot of boards that aren't comfortable with that. Now to your point, do we ever get past it? I think once we get past this election and we either have a change in administration and a change in antitrust policy or there's a sense that the here and now is going to stay for another four years. I think either one of those is likely to be significant catalyst on those deals that have yet to be brought to the marketplace. And what about the other item that you mentioned actually and that that is a question of the P&E that we hear from a lot of limited partners right now, they're a little impatient about getting some of their capital back from the general partners. Are there vehicles to get around that that you might be involved in? Well, there's there definitely are are vehicles, but let's let's just kind of unpack it what the problem is. If you have private equity firms who have bought assets in a low interest rate environment and now all of a sudden rates are meaningfully higher. There's a reluctance to monetize or to sell those assets in a period where they underwrote it at one multiple and now they're looking at selling it at a different multiple. And one of the great things about private equity firms is they are exquisite in controlling the exits. And what we're seeing is with a sense that while rates have crested, they have yet to come down. It's not going to be until rates start to come down. We believe that you're going to see a lot of monetizations from the private equity industry. And since there haven't been a lot of monetizations, they have been reluctant to continue to call capital from their limited partners. And in fact, I think we are at an extended period of time where the capital calls to investors and private equity funds continues to exceed the capital return and that's putting pressure on the deployment of capital. So private equity is less aggressive in deploying capital and they've been less willing to monetize their own assets. And we're trying to work with private equity firms to deal with those liquidity issues. Out of Milken in Los Angeles last week, we heard a lot about continuation vehicles, explain exactly what those are, how they work and how they might release some of the pressure perhaps. So the whole idea of a continuation fund starts with the premise that when you find an asset that you like and you own it and you continue to deliver superior results. This forced shot clock in monetizing it 4-5 six years in just simply to give liquidity to investors, many of whom would be perfectly content if you just continued to own the asset and continue to get excess returns. But you do have other limited partners who have other needs for the capital want liquidity. So what a continuation vehicle does is it gives those limited partners who want liquidity the ability to leave or to exit the investment and let new funds, new pools of capital come in and the private equity firm continues to own and to manage the asset. So one of the things that has relieved in the past some of the pressure on private equity has been initial public offerings IPOs, which also have gone through a period a little more fallow. Where are we right now, the IPO market and could that give relief to some of these people? The answer is of course it can but it's easier said than done. So the IPO market is healthier today than it was a year ago. I think a year ago we're looking at pretty much a shut IPO market. We're getting back to levels pre COVID like but not yet there. One of the issues is there's a disconnect between how the S&P 500 companies are performing and the broader set of companies. So whether you're looking at the mid cap, small cap companies, the Russell, all of those indices have meaningfully underperformed the S&P. And when you look at those companies, in fact I think the Russell is down over the last three years in absolute dollars. So there's been a lot of reluctance to bring companies to market because those companies that are IPO candidates better resemble small and mid cap indices companies than they do the S&P 500. And there's been this divergent, but there's been a number of IPOs that have successfully been launched in the marketplace. They've traded well in the aftermarket and that should begin to create some additional liquidity for the private equity firms to return capital to LP's to enable them to be more front footed in deploying new capital. But what's happened is as the IPO market has been shut for an extended period of time, there are a lot of these planes that are circling up in the air that need to land. And the the shadow supply of companies looking to IPO is probably more than the market can handle. O increasingly they're going to need to be other ways to create liquidity for these portfolio companies. So if you have a willing buyer, winning seller, you need to come up with the price and obviously if interest rates go up that affects the valuation. I suspect that's part of the problem here. But is the problem the level of the interest rates or the uncertainty about where it's heading, which is the more chilling effect in your business? Yeah, I I like to say that you know you either bought things in a higher low interest rate environment and you're selling it in a higher low interest rate environment and three of those four quadrants work just fine for deals. It's only when you bought things at a low interest rate environment and you're now selling them in a high interest rate environment that you end up with reluctant sellers. And right now that's the environment we're in. And what's what's making it a bit more difficult is there is the prevailing wisdom that while rates are higher, they've crested and are likely to come down. Now if ultimately rates stay at these elevated levels and they don't come down, then I think everyone's going to make their peace with the new paradigm and you're going to start to see more transactions. But as long as there's an anticipation the rates are coming down, I think you're going to see a lot of sellers withhold their inventory from the marketplace and you're going to see a more sluggish environment. You also need financing and we've heard some of the banks pulling back somewhat because of regulatory other constraints. Same time private credit we hear about every single day. Is that providing the financing, Is there any shortage of financing right now? I think I think there's there's an abundance of capital. The issue is it's more costly capital. And when it's more costly capital, prices need to adjust to the fact that you need to take on a much higher interest burden. And it used to be that you could leverage yourself at 456 times and in a low interest rate environment, the interest coverage worked just fine. Now all of a sudden you do that math with rates meaningfully higher and you need to put more equity into deals, which lowers returns. And the only way that works is you need lower prices. But there's there's an abundance of capital. Interestingly, money is flowing into credit funds from all all parts and the reason for that is there's a general sense that over time rates are coming down and if you get in now and you could ride that rate travel down, you're going to end up making hefty profits on your credit. So credit is in, you know, demand. There isn't a lot of M&A right now, so there's relatively little supply of new inventory. Most of it is refinancings. Spreads have collapsed. The issue is just the absolute rate is too high given the current environment. And I, as I said before, one or two things are going to happen. Either rates are going to travel back down, in which case we'll get unstuck, or there's going to be a growing sense that this is the new normal and folks will will make their peace with it.