Back to School – Looking Forward to the Fall Markets

Speaker 1: Welcome to TD Cowen Insights, a space that brings leading thinkers together to share insights and ideas shaping the world around us. Join us as we converse with the top minds who are influencing our global sectors.

Larry Wieseneck: Welcome once again to another episode of our Intellectual Capital podcast. I’m Larry Wieseneck, co-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 started.

David Erickson: Thanks, Larry. Well, now that I guess we’re back in school, and this is kind of the back to school edition of the podcast, I thought it’d be helpful to start from what are you expecting this fall in terms of expectations for the markets, the Fed, et cetera, to really kind of set the table for the rest of the podcast.

Larry Wieseneck: David, as you and I have joked before, and we will probably many times again in the future, if I had that crystal ball, I’d probably be doing something else. So I wish I could tell you specifically, but what I do think I can say in a more kind of general sense is hopefully a return to longer-term trends. We’ve lived with an enormous amount of noise the last three years, starting with the pandemic, lots of interventions obviously, and the distortions that were created by a lot of that. And I think the final leg of that has been the last 18 months of very active central bank involvement in terms of interest rate moves, et cetera.

And whether we’re done, we’re not, we’re close to done with this most recent regime in terms of tightening. And so I think the market is dealing with that and has been for the last few months. And my hope is that as we get through the rest of the fall, we really start moving beyond what is the next action from the Fed and we’re focused more on the real economy and then what that means in terms of valuations, are valuations high, are they low, where our spreads? And we’re doing that in a way where Mr. Market’s driving it rather than intervention.

David Erickson: So it’s been, I guess, several months now since the TD, Cowen merger. I thought we should start with how things are progressing and any recent developments that are notable.

Larry Wieseneck: Well, I appreciate you asking about that. Most typically on this conversation, talk about what’s happening in the markets and with our clients, but happy to communicate that we continue along in our integration of the businesses. It’s boring to talk too much about what we’re doing internally, but I’ll just highlight that I think we’re better organized to serve our clients than before. When you bring the two organizations together, in our case, the strengths of Cowen and then the strengths of TD Securities, as we stitch those together, we can just serve clients across more products. And at the same time, we could also deliver across more sectors. And so from that standpoint, if you’re really good with the progress, we’re starting to see where the cross-selling is allowing our clients to benefit from one-stop shopping. And that certainly is what the goal is.

We’re still in the early days. We have to remind ourselves that all of us as professionals want to see, what we really need to do tomorrow, we want to have seen done yesterday. So not satisfied with the pace, but that’s just because I’m a generally positive person and think we can do more and do it faster. But I’m really excited about that. And just a few examples in terms of things that we’ve been able to do, we’ve recently been able to announce a situation where as the sell side advisor, we were able to bring the buyer to the table and then with a separate tree, introduce our leverage financing team and be a significant part of the buy-side financing. And so there, from the standpoint of our ability to help our client, we helped multiple clients. We helped the company we’re selling for, we brought a sponsor in who was the best buyer, and now we’re their partner going forward as well.

When I say we, of course it’s a collective we because a portion that was TD Cowen, another portion was TD Securities. Just to highlight, we’re still operating two broker dealers and are in the process of doing the backend integration, but that’s just an example of something that both organizations previously couldn’t have necessarily delivered. Right. At Cowen, we didn’t have the ability to leverage finance around LBOs, and so we wouldn’t have been able to deliver that before. And from the TD security side, adding in the M&A business from Cowen has allowed them to get both sides of the trade. So anyway, that’s just one example and there’s many more situations where that partnership is creating new solutions for our clients.

David Erickson: So it’s been a while since we’ve actually really been able to talk about the IPO market, and right now we have I guess three pretty significant IPOs in the market. Obviously people are anxious to say that the IPO market is back, but from my vantage point, it seems a little premature. How are you thinking about the IPO market today and how are you advising clients as they think about potentially accessing market probably more likely in 24?

Larry Wieseneck: I’m probably closer to your view, that it might be premature to say the IPO market is back. Certainly there’s no benefit in being early in making that statement because the reality of all markets reopening, and I can recall now since we’ve been doing this podcast together for a few years, multiple times, we’ve talked about a market reopening, whether it was the IPO market, the convertible market,

David Erickson: Right.

Larry Wieseneck: The SPAC market, whatever it might have been. And I think that particularly with IPOs, we have to be careful. The IPO market is in many respects a derivative of the equity market in general, and maybe I’ll be more specific of volatility. When volatility and uncertainty in the market is most high, it’s very hard for new issues to get done and particularly for initial public offerings because the pricing of an IPO has the most questions because you don’t have a reference price, you don’t have an existing security to price it off of.

And so what we’re seeing is with volatility having come down really since the beginning of this year and settling down at a level that’s well below a target that we normally think of as you need to be below 20% in terms of the S&P volatility before you can see an IPO market start to form. We’ve been below that now for a while this year. And so we’re starting to see some big names come forward and look at coming to the IPO market. We’ll know whether the market is resilient by how we price some of these high profile deals, how they trade in the aftermarket, and then when we see some brave next issuers come forward who might be smaller, maybe a little bit less marketing names, they’re not necessarily household names. When names that are, I’m going to use an example, I don’t really mean metal bending, but when metal bending companies, for lack of better term come to the market and they can be absorbed and priced, then we have a real market.

But it doesn’t mean that I’m not excited to see a number of big marketing names come. That’s the first test, and hopefully they trade well and lead to others coming to market behind. I think give it three months. Let’s get these deals get done in September. We’re sitting here in early November, and those deals have been well absorbed. They’re trading well, others come forward. I think then for those who are a little bit less willing to be early, we’ll be advising them, you know what? First quarter is probably a fair time to go. And I think if you look at the list of names, there are a lot of names who are waiting and watching to see how the next few months go, who are prepared to come in the first quarter of next year. So we could have a very robust IPO calendar in the first half of next year, assuming the deals coming now get absorbed well.

David Erickson: Yeah, I think that’s good perspective for people to think about.

Larry Wieseneck: And David, I don’t mean to speak, the only thing I’d add there is for those thinking about coming on the early side, the key when you reopen a market, and this is just as applicable if we had said the bond market had been closed for a few weeks, or even just secondary offerings, the first folks that come have to be priced at a bigger discount to fair value in order to attract the right buyers. Folks that come a little bit later are able to get done at tighter discounts to whatever the reference is. And so part of the trade-off that issuers have to go through, and the reason why it takes a while to rebound is most people don’t want to be early and be the one that has the biggest price concessions. Right. And so that’s one of the reasons why this tend to build slowly, and it’s not a crescendo. It doesn’t just happen overnight.

David Erickson: So let’s shift gears and talk about another market that’s been relatively quiet, but again, starting to see signs of life, including my favorite snack food company, which was announced last night in terms of an acquisition. How are you thinking about the M&A market today? How is that changing and how are you advising clients to approach? You talked about a specific example earlier. How are you seeing the M&A market evolve?

Larry Wieseneck: I’ll start with at the moment, we’re seeing a lot of trades that are driven by the trend of fit and focus. When I use the term fit and focus, it doesn’t mean companies necessarily getting smaller. Some might be getting bigger, but what it does mean is that it’s about portfolio repositioning. So you might see an M&A deal where it could be a public company, it could be a private company, maybe there are multiple divisions, but they’re not at scale. They may both have, let’s say a division that is subscale and in a difficult market environment like we’ve been in, they start to question, why do I have this subscale business? If we combine these two subscale businesses, we get to greater pricing power. We get to a position of greater overall economics. And both organizations contribute those assets. Next thing you know is you have an M&A deal where now you have a competitor that’s better suited in the marketplace.

That’s the type of transactions that we were anticipating seeing, and you’re starting to see come through the market. Sometimes it’s I sell my division to a private equity fund. Sometimes it’s the private equity fund selling a business that it has some scale over to a public company that’s adding to a division. But that kind of portfolio reallocation to say we’re going to come out of this most recent period and moving into the next stage of the economy in a stronger position than we were before, is the kind of deals that we’re seeing now, which is very different than the I want to get into a new industry. I want to get into something totally different. I’m going to go buy that, what I’ll call much more of a euphoric type of environment that we would’ve seen three or four years ago. Now it’s much more rooted in competitive positioning. How do I grow my margins? How do I grow top line growth? But make sure it comes down to the bottom line.

And you’re even seeing deals that might be more about cost synergies, where two folks, maybe they don’t see top line expansion, but they think they come together, they can drive more to the bottom line. So that’s really the driver of the kinds of deals we’re seeing today. Less financial engineering, more business engineering.

David Erickson: Despite the fact the IPO market seems to have signs of life and the M&A market seems to be getting a little bit more active, the private equity space continues to be very quiet. What are you hearing from your clients in the private equity arena and how do you expect or how do you think that market’s going to reemerge in the near term?

Larry Wieseneck: I think that’s a market where we have to talk about the different sub markets. We’ve had this conversation before. I wouldn’t say in the lower middle market or middle market that it’s dead or even dormant. I think that’s continued at pace because some of the features that have made it very challenging at the upper ends of the private equity market, such as the backup in the leveraged finance business going back to last fall and the chill that had on financing, et cetera, that doesn’t have the same impact in the middle market because the middle market tends to rely on private credit, often relies on less debt levels than you would in the larger deals. So we’ve seen, I’d say the middle market continued not at the same pace as before, but with significant less dislocation.

In the bigger deals, it’s been relatively slow to your point. What I think is changing the environment is, and I’d argue this a little bit like the IPO market where we’re seeing some tests now, and if they go well, I think next year could be a fairly busy year, is the rearview mirror, the same rearview mirror that’s made it hard for folks to come forward and do IPOs because they looked at their last round and it was done at whatever, 70% higher than where they might have to get a deal done. After two years of that, right, ultimately, if they want to get public, they come public even if it’s at a big discount to the last round. We’re going through the same thing with private equity where sellers who maybe were unwilling to sell last year, we’ll use an example, let’s say their valuation would’ve been 12 times EBITDA in 2021. They’ve had to go through a cycle before they get comfortable that their industry is now a nine times multiple industry.

And the private equity folks who might’ve wanted to buy that company a year ago, were waiting saying, I’m not going to pay yesterday’s valuations for tomorrow’s value. Right. So they had to wait. And now we’re starting to see that capitulation where the sellers are starting to recognize if it makes sense to sell, these are the valuation levels. And at the same time, the private equity funds are less concerned about being embarrassed and buying at the wrong price because we are seeing a stabilization in rates. A stabilization in rates means they can lock in their financing, which means they can put together their models, figure out what the IRRs would be with less concern they’re going to get it wrong. And so now you have a market, right, because buyers and sellers can figure out if they can cross.

And so we are definitely seeing that start to emerge. The biggest challenge at the higher end of the market though is still that the large syndicated loan market has not completely thawed, right? There’s been some thawing. We’ve seen a lot of the positions that were brought on to folks balance sheets in the fall and that were stuck have begun to be sold off. So those inventories are coming down, which usually means we’re getting closer to a period where we’ll start seeing a pickup in financing and deal flow. So all that leads to the very high likelihood that going into the new year, we see a pickup in activity inclusive of the private equity players.

So we’ll see how that goes. I will say the one area where private equity has continued to be pretty active though is in the portfolio transformation. So similar to the comment about fit and focus in general, if a private equity fund has a platform that they bought and they bought well, and the market was challenged over the last 18 months, portfolio acquisitions where taking that platform company buying a weaker competitor who maybe was under financed, these guys have the backing, buying them, appending it to the business. We’ve continued to see that pretty much unabated over the last 18 months. A little bit of the have and the have nots. Right. Those who have strength, well financed buying competitors that were in a weaker position

David Erickson: Yeah. On other podcasts we’ve talked about, occasionally about other areas of the market that really don’t get a lot of attention, but that clients should be aware of. Anything in the recent past that you want to discuss in that regard?

Larry Wieseneck: Well, I think the market or sub-market that has been viewed to be dead over the last certainly 18 months is the venture space, right? There was so much discussion of growth and what was going on in the venture community back in 2020 and 21, and because of challenges in technology and disruptive arenas, we’ve had very little dialogue about that over the last year plus. And I do think that what we’ve seen is that’s starting to pick up again. Part of that is that funds, venture funds not dissimilar from private equity funds focusing on their existing portfolio and adding to it. Most venture capital funds have been focused on their existing portfolio. So what I think people haven’t really noticed is that there’s been a lot of activity, but what it’s been is a sorting of, okay, which of the businesses that we invested in should we basically walk away from and let go?

We’re not going to defend it, we’re not going to add more capital to it. And which are the ones that, while it might not be an up round, it might even be a down round in order to properly finance this. We’re going to continue to invest because it’s a great business, not just great technology, but a great business. Generally that’s been companies that have found a way to significantly diminish their cash burden or even better, have found a way to get to break even such that you’re not funding a product, you’re funding a company. And I do think that’s a difference, right, which is when you start to be able to show that you can have real margins, the venture community will continue to invest in you in second, third, and fourth rounds. And so that’s what’s happening as we speak. We’ve seen it now for the last 12 months, but it’s been mostly under the radar and that’s crowded out a lot of new investing. Right. People were focusing on their portfolio.

I don’t think we’re out of the woods in that yet, but we are starting to see the beginning of ideas getting funded, and particularly if they’re in hot areas. In our prep talk, we talked about things like AI and the such. There’s certain areas where not only are they getting a lot of attention, but they have the opportunity to be category killers. And in those situations, we’re seeing new funding happening beneath the surface, even though you don’t see it widely reported. So again, I think that the venture market has gone through a lot of soul-searching the last 24 months, and we’re on the uptick there as well. I mean, if I were to summarize in general, it does feel as if a lot of the challenges that we’ve gone through the last 24 months are starting to go behind us. And then the only question becomes what is the new equilibrium? And that may be for another conversation. We could talk about is 2019 the right comparison? Is 2018 the right comparison? But it’s clearly not the second half of 20 or 2021 where there were a lot of excesses in the market.

David Erickson: Well, at least the good news is that we’re directionally going the right way versus some of the recent podcasts we had back to when we were talking about Silicon Valley Bank and some of the other issues that we had earlier in the year. So that’s clearly, directionally we’re going the right way. The challenge is how quickly and how big are we going to get there when we get there? So.

Larry Wieseneck: And then the one thing that I do think continues to be an issue that’s hanging out there is, there are new capital requirements coming for a whole host of reasons, again, we have a whole conversation on that, that will have a restrictive element on the flow of capital, certainly bank capital. And when the banks lend less to various parts of the community, that has an impact on the real economy. And I don’t think we’re done necessarily with the regional banking challenges that we saw. We have to be mindful of that and the role that both regional and community banks play, certainly here in the US. So I do think that while we’re optimistic, it’ll be a better environment over the next 12 months than the last, it’s with caution. It’s cautiously optimistic because I do think there’s some real headwinds.

And then the last piece that it’s hard to believe we have to start saying, but we’re almost a year away from the midterm, [inaudible 00:21:11] midterm, the presidential, and obviously Congress and a third of the Senate. And that’s going to start taking up a lot of focus, at least in the domestic markets as we start pricing in the possibilities of what that might bring. So that’ll be a topic for the future as well.

David Erickson: No question about it. Well, as always, thanks for the time. We’ll pick up some more topics during the next podcast.

Larry Wieseneck: David, thank you. Always appreciate your help and conversation. And so I will just end by thanking our listeners, and of course, as I just said, thanking you for your preparation and for being a great thought leader.

Speaker 1: Thanks for joining us. Stay tuned for the next episode of TD Cowen Insights.

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