Larry Wieseneck, Head of Global Investment Banking at TD Securities is joined by David Erickson, Senior Fellow at The Wharton School. They discuss the current state, potential catalysts, and outlooks for the IPO, M&A, private equity, and venture capital markets.
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Welcome once again to another episode of our Intellectual Capital podcast series. I’m Larry Wieseneck, head of investment banking at TD Securities. And once again, I’m joined by my good friend and former colleague, David Erickson, senior fellow at the Wharton School. With that, let me turn it over to David to get things rolling.
Thanks Larry. So while 2023 was a great year for the equity markets, it has been really a lack lister for deals, especially IPOs and M and A. So as we start, we’re in late January now, what’s your outlook for the balance of this year and maybe even a little bit longer?
Well, David, I’ll start with saying I don’t think I’m going out on a limb to say that we think 24 will be markedly better than last year, but since you indicated it was pretty lackluster last year, that’s not saying all that much. But what I’ll say is I think it’ll actually be a pretty good year, not just better. I think it’ll be a pretty good year, and that’s for a whole host of reasons. But if we start with the M and A market, what I’d say is we’re at a point now, roughly 24 months since the overall market started to trade off two years ago based on first fears and then the reality of interest rate cuts and what was going to be needed to fight inflation and get the economy, let’s just call it balanced, that move, first the fear and then the reality of significant rate cuts took away risk taking across the board.
It affected the broad equity markets. It obviously then affected new issue markets, IPOs, and then M and A. And the reality is buyers and sellers have to be able to agree on value and it was most acutely felt in M and A and in IPOs, the two areas where there’s the least price discovery and there’s the most risk-taking involved. And so it was a very challenging year last year after a down year in ’22. And yes, we think ’24 will be a better year.
So with the IPO market showing a few signs of life back in the fall, unfortunately a few of those deals just haven’t traded well. You talked about there’s got to be better price discovery between buyers and sellers to kind of move the IPO market from more sporadic to a more normalized market. What are other things that you think need to be in place to make a more consistent IPO mark?
Well, unfortunately, I’m going to say unfortunately because it’s going to highlight you and I have known each other a long time. I say unfortunately we’ve had this conversation many a time over the last 20 plus years or more, but the IPO market is really not a market. People like to talk about it as if it’s its own market, but it really is a derivative of the broader equity capital markets.
And as I said a moment ago, it’s arguably the most fickle and the one with most risk because I don’t have an ability to see where bids and [inaudible 00:03:23] been over the last day, five days, month, year, et cetera. We have to actually move forward and find a way for buyers and sellers to come together. And because of that, when you ask the question, what will it take to see more depth in that market? I think the first thing is we need to see the equity market strength that really came along in the second half of last year and was most pronounced still among a handful of names. So I think as everyone listening would know, there was a real dichotomy between what the highest valued or we’ll say best performing stocks in the S&P or the NASDAQ posted last year from the rest of the market.
So as that broadens out, that leads to more new issues in terms of secondary offerings and follow on offerings as that takes hold the next place where you see deals come to markets in the IPO market. And so I think as we see more stability, David in the market overall, I do anticipate this first quarter you’ll see an uptick in secondary offerings. We certainly saw December was pretty good, we now get into January and the problem is numbers start going stale so people can’t come to market. And then what we’ll start seeing is kind of mid-Feb on, I think if the market continues the way it has been so far this year, we should see a decent amount of follow on offerings and then we’ll start seeing in the latter part of the quarter IPO is picking up, and if there’s success and it’s an important issue, if the first deals that come have success and investors make money and companies have a good shareholder base, then it’ll encourage others to come forward.
So our view is the first half we see an uptick and then as we move into the middle of the year, that will continue with additional volume. The one big question mark is we’re in an election year, so if we were talking about any market other than IPOs, I would say it’s going to be front loaded. I think secondary offerings we should see more in the front end of the year in the second part of the year. Certainly in investment grade debt we’re seeing in high yield, it has been a pretty busy beginning to the year as issuers who know what they have to do in terms of financing are trying to get ahead of the volatility. That always comes up in a presidential election year. And this year more than ever, I think volatility is a word to describe what we think is going to happen around the presidential. So certainly all those constant people would love to come first half into say July and avoid October, November.
Yeah, it seems like a strange year, especially as you said with the election year and especially on the back of, I guess, results from New Hampshire earlier this week. It just seems like there’s not really going to be even primaries this year. And so it’s going to be all about the general election starting now almost.
Well, if you can ever say that presidential elections are boring, we might be bored for a while here going until the real sizzle of the conventions. It is a long time. We actually had our team from Washington Research Group recently talk about this and if in fact the Republican side is wrapped up over the next week or so, which again it’s not the next week, maybe it’s the next month, we’ll see if that’s the case. This is really early when the convention is as far away as we’re talking about, it’s August for the Democrats and July for the Republicans. So we’ll see. We’re not in the business of crystal balling politics, but it’s just a wild card that everyone needs to be thinking about from the market standpoint that once the convention comes for sure, that period the markets could be wide open, they could also be extremely volatile and therefore very difficult to get new issue done regardless of markets. So we’ll just have to see.
So let’s flip to the M and A market earlier this year we started with a few strategic deals announced in biopharma and healthcare, but the rest of the M and A market remains pretty quiet across sectors. What sectors are you seeing the most dialogue in or conversations in and what are the types of catalysts you’re expecting to drive activity as we see the balance in?
I think it’s a really interesting dynamic when we talk about the M and A environment. Last year, let’s just say the last 18 months. So last year and the second half of ’22 was challenged because not only did we see a downturn in large cap M and A, which broadly is tied to where valuations and evaluations came down and interest rate risk move forward, we saw companies be much more cautious. But we also saw in the vast middle market, which is every year becoming a bigger and bigger part of the overall M and A market, we saw a real chilling effect driven mostly by the fact that financing was becoming much more expensive. And because in late ’22 we saw a number of large syndicated loans that were not fully distributed and hence sitting on bank’s balance sheets. And that also meant that the syndicated loan market was stuck. And so if the financing market is challenged, that has a huge impact on the ability for, we’ll call it the sponsor in particular sponsor related M and A deals to get done.
Much of that has thawed. So the vast majority of what was say a year ago not distributed, has been distributed. Banks will be able to get their books into order. I think the private credit market continues to grow in importance. And so we have a market that, again, as long as you’re comfortable with where interest rates are, and I would say 18 months into what has been a tightening cycle, which now seems to be now neutralizing, the market’s pretty open for financing. It’s not as aggressive as it would’ve been say two years ago, but deals can get financed. It now comes down to whether buyers and sellers can agree on value, and I think that’s the most important thing. We do believe the M and A market is thawing if not significantly improving, but it’s mostly because the proverbial rearview mirror, it no longer incorporates some of the very high multiples that in really every sector were there 24 months ago.
So if you’re in a cashflowing business that is easy to borrow against, you’re looking at almost every sector, I’d say almost because they’re a handful where valuations are actually higher, but in almost everything, because obviously discount rates reflect interest rates as part of that multiples are down. And so management teams and owners that are comfortable that, you know what, we’re not getting back to 2021, ’22 type multiples, they’re willing to consider selling now. And then on the buy side, it certainly looks like far better multiples to buyout than it did two years ago. But the question is you have to be comfortable that they’re not going down lower. I think we’re at the point now where most people feel that, again, other than the highest valued sectors, we’re at a point where buyers and sellers can meet. So that kind of change in animal spirits, if you will, has really only kicked in the last few months.
So we’re definitely seeing backlogs grow, we’re seeing more owners of assets thinking about selling. And one of the things that you just can’t ignore is at the end of the day, tigers do what tigers do and dogs do what dogs do. And when you think about the role of private investors in the private equity market, the majority of investors, they can hold off for a year or two from putting new money to work. And on the other side, if something’s matured in their books, they can wait a year or two before they sell, until they get to a point where they’re comfortable. But at some point the owners of these assets need to sell and the buyers need to start putting money to work. And so we do think that the waiting period is getting old for most of those investors. And so our first priority is we think the private equity related deals will pick up with public market deals, probably being a bit lagging as it relates to percentage increases, but that will also kick in the second half of the year into next year.
Saying in another way, you think most of the activity is going to be more sponsor driven than strategic company to company.
I think that the balance will be that we’ll see the private market leading the public market in terms of opportunity with one exception, which is I think we’ll continue to see. We’ve talked about this on this call and we certainly talk about this with our clients, that the public companies coming out of this challenging environment the last few years feel the pressure more than ever to justify the business they’re in. So the term that I like to use is fit and focus. I think fit and focus deals will continue. I think businesses that might maybe are in three or four sectors decide that there’s two that they’re really good at, the other two they’re not as good at, and they spin those other assets off, whether it be public market transaction, whether it be selling to another strategic or whether it’s selling to private equity. So the world of take privates, the world of swapping assets, I think that’s continuing to be or will continue to be a big part of the activity, but I don’t think we’re going to see an enormous number of is huge MOEs.
I think that certainly with this justice department, but I don’t think it’s just here in the US I think globally the focus on monopoly power, the focus on protecting consumers is such that it is more and more difficult to do large MOEs and the majority will be much more add-on and tuck-ins.
And so you talked about private equity, obviously it’s been very dormant in the private equity markets, whether it be monetizations on their behalf just given there’s no IPO market and there’s been no IPO market and there’s been very little end in terms of M and A, and it’s been very challenging because of that to raise capital or new money. But according to Bain, they have something like over 3 trillion in dry powder sitting out there in terms of private equity funds to deploy in terms of deals, how do you think that’s going to loosen up? Is it putting more equity in like we’ve seen or are we going to start to see a little bit more activity in terms of more leverage transit?
I do think that we will get back to a time where leverage creeps up. Again, that’s not where we are right now. I think that most situations we’re seeing have a significant equity check associated. There’s a reluctance for a whole host of reasons, including oversight, et cetera, to put significant leverage onto situations. Another thing is just interest rates are higher so the economics don’t look the same, right? So when you look at the cash flows et cetera, and how much leverage someone could take on, it’s different when you’re looking at zero or 1% rates versus a base rate of 5% or thereabouts. So I do think you’ll see more equity, but I think to your point, private equity firms are incented to put money to work.
And so what I said earlier, you can wait a year and a half, two years at some point you have to find a way to put that money to work. And the same thing is true on the other side, which is that in the end, for the vast majority, not all because there’s some funds that are set up where they get incentives tied to NAV, et cetera, but most it’s tied to monetizations and so you can’t wait forever to monetize. So I do think that those two sides of the equation, I’ve got to put money to work and I have to monetize the other side, is going to lead to an ultimate thawing in the private equity world. As you said, I think it’ll be bigger equity checks as a percentage, but I also think that we’re at a point where the winners are going to keep getting stronger and those are average are going to suffer.
You talked about the fundraising environment, there have been some very, very strong fundraise in the last 12, 18 months coming from those that have great track records and investors want to put more money there. On the flip side, those who’ve struggled or had average performance are finding, not that they can’t raise as much as they would’ve, they’re finding that it may just be dry for them, and so they put off fundraising until they can have a better story.
So it is definitely becoming a market of haves and have-nots and there are echoes in what we’re seeing in private equity to what we saw probably 20 years ago in the public mutual fund world, which was it was getting harder and harder for folks in the middle to operate. You either had to be truly a large player with scale or you had to be very nimble with a very small focus and argue that you were the best at fill in the blank sub-sector or subcategory. We’re starting to see that now in the private equity and venture world where either the two ways you become a have is you either are very, very good across significant number of areas or you’re deep in your sub area focus, you do nothing but that expertise.
So as with previous podcasts, we’ve occasionally touched on areas in the market that don’t necessarily get a lot of attention the client should be aware of. As we start a new year for 2024, what should clients be looking for having their eyes on?
So I think there’s two themes that we’ve maybe touched on here and there, but we haven’t really talked about as we’ll call it issues to focus on, and I think are worth now saying their time has come. I think the first would be the reality of secondary transactions and continuation funds. So the natural extension of your question before about private equity and not necessarily wanting to monetize in a challenging environment is you have a lot of assets being held in the private equity world where the sponsor that controls it really likes the asset, but their investors who’ve been in it for a while may not necessarily want to continue to have that investment.
And so the market has continued to evolve in terms of ways that the private equity fund can extend their time period that they are associated with the asset and change up their LP base. And so one way is I sell that into a continuation fund, whether it be a general continuation fund or maybe specific to that deal. And the other is providing liquidity options to the investors through secondary trades. And I think that that’s something which is here to stay. In the last year the SEC started focusing on it in terms of trying to understand it better. I think anytime you see the SEC start to look at an opportunity or an issue in the private market, it means that it’s happening with some significance in terms of the number of trades.
So I think that’s something that again, clearly people need to be cognizant of, but importantly, I think it’s a positive development as long as they’re done the right way with the right governance, look, it’s hard to find a great asset and if a private equity fund has spent the time added value, they know the asset well, they know the management team well, the idea that they must sell the position in order to get the monetization that is tied into their alignment of interest with that company. I think if they think they can add value and invest in it for another five years, having more ways to do that is valuable and that’s what we’re seeing with those elements.
The other theme that I think is with us and is not going away is the role of very flexible private capital, and private capital from the credit side comes in a lot of different forms, whether it be direct lenders, which allows the middle market to operate very efficiently in terms of the sponsor space, whether it be accessing credit, which might have slightly different terms than banks would lend at, but provides for issuers or borrowers the opportunity to really trade off well, I could go to the bank market, I get certain terms there, some were better for me, some might be slightly worse. Or I can go down the private market and again, I’d have different trade-offs, but it is now allowing the loan market to look and feel a bit more like the equity market where I have different options in both the private and the public path, and we think that’s healthy.
We think in the end, the more options that companies have for how to fund themselves and who to partner with, then the better they are going to be in terms of fulfilling their mission of creating value for their shareholders. So we’re very supportive of both markets. We certainly participate in both markets and look forward to seeing how that plays out in ’24 where I think it will continue to be a banner year for the growth of private credit markets.
Great. Well, thank you Larry for, it’s been great to start the year hopefully, and knock on wood, we’ll have more to talk about when we touch base again in another couple of months, but look forward to talking further.
And David, always a pleasure talking with you. Look forward to our next conversation. And for the listeners, thank you for listening.
Thanks for joining us. Stay tuned for the next episode of TD Cowen Insights.
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