In its latest issue of Global Capital Markets Perspective, Deloitte points to widespread activity in 2013 and the prospect for further gains in the months ahead. However, the report also perceives some fragility in trends – and the possibility that growth could be up-ended by sudden shocks.
One of the report’s authors is Robert Olsen, a Deloitte partner and national leader of corporate finance at Deloitte Canada. Olsen spent much of his career as a private equity pro. Prior to joining Deloitte, he directed the Canadian operations of Goldman Sachs Special Situations Group, and before that, he was co-president of CCFL Mezzanine Partners.
I recently had the chance to speak with Olsen, and ask him about the findings of the Deloitte report–and its implications for the PE market.
The latest issue of Global Capital Markets Perspective strikes a positive note about trends in 2013. Will growth continue in 2014?
Olsen: We are optimistic about 2014, because we feel the key variables are in alignment. These include improved economic conditions, low interest rates, strong investor confidence, and abundant liquidity. However, the activity of global capital markets these days is closely intertwined with political developments, which can quickly derail things. Most of our optimism is centred on developing economies. We are currently less optimistic in the short term about emerging economies, and have some concerns about events unfolding in certain BRIC countries, such as China. We are also keeping an eye on specific markets, such as high-yield debt. That market has shown record issuance over the past four years, which concerns me as it can’t go on forever. It is also highly vulnerable to sharp spikes in interest rates. I’m also concerned about the bifurcated nature of opportunities. At present, big corporations have substantial cash, plus virtually unlimited access to debt and multiple other financial options. For mid-market companies, the options are fewer, which might result in many having to go the M&A route.
Global M&A activity has been lacklustre of late. Will changing economic fortunes soon give it a lift?
Olsen: There are several things working in favour of renewed M&A activity on a global basis. For example, there is much greater capital availability. Strategic investors and PE firms are sitting on a mountain of cash. When deployment of this money truly gets underway, we’ll see an explosion in M&A transactions at levels we have never seen before. Big businesses are perhaps the most important factor here, as they have so far been unwilling to invest. But in my conversations with corporate CEOs I sense more optimism, and more of a willingness to put cash reserves to work. For this reason, I think we will absolutely see improved M&A deal-making in 2014. The momentum is there so long as there are no major shocks emanating from one or more of the world’s political hotspots. People are feeling more optimistic, but they are also feeling cautious, and a sudden blow-up can quickly undermine growth in the M&A market.
Your report suggests that North American private equity will be the beneficiary of current trends. Why is that?
We believe that North America will generally be the first and main beneficiary of improvements in global capital markets in the near term. Private equity investors will share in the benefits, chiefly because of economic optimism in the United States, greater liquidity, and sustained recovery in equity markets. It is also easier to transact in North America. Eventually, opportunities will also materialize in other regional markets – for example, when the moment is right, PE investment in BRIC countries is likely to increase overnight. However, for now, North America will be the leader.
Do you believe that exits are providing much of the impetus to the PE market? Will trends support the reduction of aging portfolio assets?
Olsen: Yes, the best opportunities might well be exits – M&A transactions and dividend recaps have been key drivers. The ability for private equity firms to sell portfolio companies is these days amplified by the sheer volume of money out there. For strategic buyers of PE-held assets, the incentive is often the synergies created by acquiring businesses that fit into long-term commercial plans. My sense is that sales are most prevalent in specific sectors, and where capital is most readily accessible. Again, the market here shows its bifurcated nature – opportunities are perhaps fewer at the lower end of the mid-market because liquidity is more restricted. As big businesses and large PE houses lead growth in M&A activity, there will be important consequences for the mid-market space. This will be supported by improved equity markets, as corporations rely increasingly on stocks to make acquisitions, and not just cash reserves. This will help relieve the bifurcation and enhance exit opportunities.
Some private equity investors are concerned that growth in liquidity is leading to aggressive pricing. Are you also concerned?
Olsen: Markets are overheated at the present time, especially in the United States. This is unavoidable as liquidity becomes more plentiful. It is, of course, understandable that PE firms want to be smart about how they deploy their capital. That’s true of all market players. Due to economic uncertainty, a lot of businesses have to date held back from selling. And, as I mentioned earlier, a lot of strategic money has remained on the sidelines. When the market achieves more clarity, and both buyers and sellers feel they have entered a comfortable operating environment, the scenario will change. And the result will be enough tailwinds to encourage overall growth. For this reason, we are positive about the future, though we do have concerns about the impact on pricing. We are also concerned about easy credit and more covenant-light debt instruments. These are all risk factors that bear watching.
Is Canada’s private equity market and fund industry in a good position to take advantage of improvements in global capital markets?
Olsen: I believe so. The domestic market has so far benefited from Canada’s solid banking industry. And I think Canadian buyout and other private equity firms have done well, because they have assumed a greater international focus. They have also increased their competitiveness by specializing. This will allow them to access lots of opportunities going forward. However, they will have to be careful about competitors – such as U.S. competitors which operate with a clear advantage with respect to accessing aggressive debt options. The majority of Canadian PE firms are focused on mid-market deal flow, and the North American mid- market of today is inundated with investors. It is nonetheless easy to feel good about the prospects for Canadian PE firms, especially as we anticipate significant growth in M&A that involves mid-market businesses – both at home and abroad.
Photo of business growth concept courtesy of Shutterstock.
Photo of Robert Olsen courtesy of Deloitte.