Optimism Grows for M&A Market Resurgence

Warren Estey:

Welcome to Markets Plus, where we cover the latest market, economic and business trends. I’m Warren Estey, Head of the Investment Bank at BMO Capital Markets. I’m thrilled to introduce today’s episode with Alan Tannenbaum, CEO of BMO Capital Markets. Alan recently joined a panel of industry experts at the Milken Global Conference 2024 in Los Angeles to discuss the M&A market, moderated by Bloomberg Television’s Romaine Bostick. With inflation cooling, markets stabilizing and companies sounding more upbeat, could interest rates cuts – and a resulting resurgence in M&A – be on the horizon? That was the focus of the M&A: Moving On and Up panel. Let’s listen.

Speaker 1:

The views expressed here are those of the participants and not those of BMO capital markets, its affiliates, or subsidiaries.

Romaine Bostick:

We talk about this idea of M&A and maybe the resurgence of M&A. I guess the big question is did it ever really go away? I know volumes dropped, but when you look at what actually has been transpiring over the last couple of years, what did that tell you about where we are? Alan, I am curious from where you're perched here, has the opportunities for financing these deals, are they better now than maybe what they were a year or two ago?

Alan Tannenbaum:

The markets tend to have stabilized given the interest rate environment. However, we see markets continue to be fickle. You seem to go through cycles and sometimes those cycles could be as short as a week or two where it appears that the window is open, and financing markets are very robust and not surprisingly, you see the corporate activity really pick up, and you've seen that because they can react quickly. The M&A cycle being much longer, and you're looking at financing further out, that aspect of the decision-making and how that fits into the quotient around whether or not to move forward to the transaction is more relevant today than ever. And part of what we've seen as a response to that environment is more all-stock deals.

So, for example, we've seen this year just a higher percentage of our clients looking to use their paper as their currency as opposed to exposing themselves to potential financing markets.

So better today than it has been for a while, but something you really have to watch day to day and week to week.

Romaine Bostick:

Well, that's good for the larger companies that are in the publicly traded companies that have the stock to do that, that gap between how a buyer views the valuation and how the seller views the valuation. I know that gap has been wide, but has it narrowed it at all?

Alan Tannenbaum:

You've seen a complete shift in the sponsor market. We see that as somewhat temporary, however, that the investment returns that the LPs have become accustomed to are in the high teens, and ultimately, for that market to thrive the way it has, 50% plus equity checks is not sustainable. Our view is that for the sponsor community that's putting the capital to work, they're finding great opportunities and great companies. Our view is the bet that they're making is that 12 months, 24, 36 months from now when markets normalize, they're levering those companies up more appropriately at cost basis that makes sense. If you think about, again, a 10% cost to capital, if you lever a company six times, you've destroyed your EBITDA and your ability to grow and invest. So the math is pretty straightforward that you have to adjust for, at a 10% interest rate.

So our view is that that market has stabilized such that people are doing transactions. It's better. It's not great. The gap between buyers and sellers is still there. We talk about planes on the runway. It's the portfolios that have to be sold and monetized that really has to kickstart this next phase of really robust M&A, and financing markets, hopefully adjust as well, such that all those pieces align, and we get a really robust environment somewhere '25, '26.

Romaine Bostick:

I want to get to one of the audience's questions, and I'll pose this to you, Alan. And this gets to the idea of the dollar strength, and it gets back to the idea of cross-border deals and whether the dollar strength might aid that with US companies looking for deals.

Alan Tannenbaum:

The dollar strength; if you'd have asked an economist 20 years ago to close their eyes and talk about the US having $35 trillion accumulated deficit, a trillion dollar annual deficit, they would've said, "Wow, the dollar's collapsed." This is unheard of in the current economic environment that you have a dollar as strong as it is, which is, if anything, a reflection of the rest of the world. So it's a reference currency relative to everybody else. So we live in such unusual times.

The dollar strength is really just reinforcing for, as we think about our global companies, why you need to have exposure. So it goes back to whether it's 45% of the equity capitalization globally, you're very hard-pressed if you are a global company or even a regional, a geographically limited organization, not to have exposure to the US dollar such that you are not balancing out your costs, your revenue, so that you are in a place where you can have relative exposure.

And that's why we are seeing a number of companies looking to get exposure to the US, not just for the strength of the economic market and what's obviously been a stronger US economy than most of us anticipated at this point of the year or this point of the cycle, but it's about being balanced such that your P&Ls are balanced, and your currency exposures are a little bit balanced out, and that is part of what we are seeing as a driver for acquisitions here in the US. So it's part of the equation for considering opportunities. I wouldn't say it's the primary driver. It always goes back to what's the industrial logic.

The one thing that we dove right into it, but feel like has not been lost in this environment, is the strategic logic of M&A. To me, that discipline, maybe the bar has gotten a little bit higher given the economic and the market and the financing environments and everything else that we're dealing with, But to me, the industrial logic continues to be very disciplined, very strong, and where companies see opportunities to strengthen their operations, solidify the risks, or manage their risks better, whether they're currency risks or economic exposures, that's really what's driving these transactions.

Romaine Bostick:

You're clearly aware of all the regulations or potential antitrust issues being raised, particularly against some of these big tech companies, and that seems to have put a chill on some of those acquisitions, particularly some of those bolt-on acquisitions that we used to see all the time from the big companies. But is there a case to be made, at least for those folks that have the resources and, more importantly, at the time, is it worth trying to move forward with-

Alan Tannenbaum:

If I could just add in one element that is maybe a little bit positive. For all of us who are practitioners, what we're also seeing is some complexity in these transactions, which gives room for us to add value as bankers, which is sometimes positive. We're in a couple of these situations that are tied up in the regulatory geopolitical issues and being around the hoop, being able to deliver creative solutions to allow companies that if they're willing to divest certain assets, there are parts of it, partner on certain pieces, find a domestic partner to resolve certain issues, there are really creative, interesting solutions that can get you to the finish line.

So there's closure risk around it in the market today, but I feel for our franchise and for all of us, the opportunity to add value in those situations and to really help guide our clients through some of these prickly situations can be quite rewarding.

Romaine Bostick:

I want to pivot to another audience question. This has to do with portfolio companies where the sponsors are feeling leverage, cash flow, covenant type of stress here. The question is that as they've held on and even put in new equity, what happens if we get into a higher for longer environment? Does that dampen M&A for those folks? It kind of gets to that idea of really there does need to be a lot more guidance in this environment than in the past.

Alan Tannenbaum:

I keep chiming in slightly more optimistically. There are 28,000 companies. Most of them are good companies. The good news is that maybe they're slightly over levered for some portion of that. I look at our portfolio companies, and again, we have lending exposure to these companies, so we're tracking how they're performing. The performance is quite good.

So we're optimistic that A, equity markets have to normalize. You talk about the hundred trillion dollars of value, there is a broad deep capital market, particularly here in the US for those companies. So that has to reopen.

We love the creativity. As was indicated, our sponsors are being more creative around how to raise fresh capital, bring in new partners. In my mind, what they're struggling to also do is retain some of the upside in order to deliver on some of those returns while shaking loose some of the companies in their portfolio. And these are creating opportunities for us to access new investors, the private capital markets that we keep talking about.

They're obviously been mostly focused on private credit, but there's lots of appetite for private equity. The growth in family offices in alternative capital pools, being able to access those types of pools of capital to bring in minority investors to retain some upside again and create some value for their LPs along the way. We're also seeing increased usage of fund facilities, margin lending, various leverage tools that are allowing for access to capital to create some of this liquidity to just create more optionality for the sponsor.

So we are seeing a lot of creative tools around this process, and there's still a reluctance to accept the reality of pricing. It's gotten better. We love all of our children equally, but at times we have to let them go and move on with their lives. So that will happen.

Romaine Bostick:

Yeah. We talked so much about what's happening in the here and now, and maybe I'll go back to the optimism, Alan, that I think you were trying to bring in here. But I mean, you guys have to also be thinking a lot now about some of these bigger, broader structural changes in our economy and our world, and how that's going to drive deals and really just drive our economy here. What are the more bigger potential things, the ones you really think has some substance behind it, Alan?

Alan Tannenbaum:

I'll just start with a point which I feel is now starting to get better attention, but is a huge structural issue for our markets, and that is the balance between passive and active investing, the shift. If you go back 20, 30 years, when the whole concept came into being, I don't think anybody anticipated that it would dominate the market the way it is, that for most of our public companies, the largest shareholders are all the passive investors. And the whole concept is predicated on active investors setting a price, which therefore can be copied by the passive investors. And that probably works when passive investing is 10, maybe 15 or 20% of the market. When it's 50% plus, it doesn't work. It's very hard to go on an IPO roadshow and talk to a computer and try to convince them to participate in your deal.

So you're talking about dislocations in financing markets that were probably unanticipated than the unintended consequences we are now dealing with, and there has to be some level of balance. And again, if everybody continues to believe that passive investing is the only way to achieve a reasonable rate of return, eventually the market will go away. There will be nothing left. So you have to reach a point where cooler heads step in and say, there has to be some way to mitigate this because it's unhealthy for our market.

So I'll just stop with that one element that, over time, we're going to have to address.

Romaine Bostick:

All right, really appreciate it. So smart. Please give a round of applause.

Speaker 1:

Thanks for listening. You can follow this podcast on Apple Podcast, Spotify, or your favorite podcast app. For more episodes, visit bmocm.com/marketsplus.

Thanks for listening. You can follow this podcast on Apple Podcasts, Spotify, or your favorite podcast app. For more episodes, visit bmocm.com slash markets plus.

Speaker 3:

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