Want to Get Financings and M&A Deals Done? You May Need to Reset Your Thinking

This month at WSJ CFO Summit, I participated on a panel alongside Paloma San Valentin, Head of Corporate Finance Group at Moody’s, and Frank Parker, CFO of Cart.com, looking at debt raising and restructuring in the current rate environment, and other considerations that are expected to influence deal making in 2023. Following years of acute macro and market conditions, this year promises to set a more normalized tone as corporates and investors acclimate to higher rates, slower global growth and ongoing geopolitical tensions. Yet, opportunities will not be accessible for all, and ingenuity and a reset of mindset will be required to get deals and financings across the finish line.

While volumes of bond and equity issuance and overall M&A deal activity remain subdued, especially compared to the record activity of 2021, the overall level of activity appears to be reverting to the 5-year averages. Last year was certainly spent contending with the hangover of supply chain issues, concerns around an impending economic slowdown, persistent inflation and the resultant rising interest rates, and volatility spurred on by geopolitical tensions from Ukraine to the US-China bilateral relationship. Now, there are signs that both corporates and investors are digesting these stressors and moving forward. On the equity front, the VIX is around 20, a level most consider issuer-friendly. And as companies are coming out of the earnings’ blackout, investment grade debt issuance has picked up as well. While the market is still working through the current non-investment grade backlog, we are seeing cautious activity in that market. Across most market segments, I expect we will see a return to longer term trend lines.

That said, the return will not be uniform. During the panel, I posited that opportunities for deal making will be company specific, sector specific, and transaction specific. Investment grade, well capitalized companies with established bank groups will continue to have access to capital, while those with a more mixed record may struggle. Though broadly more skeptical of the outlook for corporates, my fellow panelist Paloma San Valentin agreed, noting that investment grade companies and those on the cusp - think BBB - will be resilient, while those on the lower end of the ratings spectrum are likely to face refinancing and default risk. The same divergence of fates will be true across sectors, with investors favoring some verticals over others.?

Getting deals across the finish line will also require some structuring ingenuity to both bridge the bid-ask spread in purchase price and financing. Frank Parker of Cart.com sees an increase in more structured deals with downside protections (ratchets, warrants) and upside equity components. Alternatives may need to pony up more or all equity up front and lever the companies later once they achieve cost optimization and increased operating margins. Some examples include the buyouts of Coupa, Zendesk, ForgeRock and Ping Identity. Private credit is already playing a larger role. While historically dominating the midmarket, they have begun participating in larger transactions. Portable capital structures are providing greater flexibility for companies and banks are selectively funding debt on their balance sheet. For an example of creative financing, look no further than the Blackstone transaction, which took a smorgasbord of options to fund the acquisition of a majority of Emerson’s Climate Technologies including the seller rolling some equity and issuing a note, private capital, and debt funding by the bank group.

Finally, the panel agreed that now is the time for caution, preparedness, and a focus on cash flow. As Moody’s Paloma San Valentin pointed out, we are going into a period of slower growth with higher costs and demand volatility and some companies have not prepared for this moment. Given these macro headwinds, I believe companies are well served to heed the adage of raising money when they can, not when they need it, even at a higher cost to avoid the whim of financing market windows. Cart.com CFO Frank Parker underscored this, noting that the balance of power has shifted from issuers to investors, and profitability has eclipsed growth as the priority indicator. He also emphasized that if your company doesn’t have a path to profitability, you are no longer going to be able to raise capital

As market participants recalibrate to the normalized state, deal activity will pick up pace, and we are already seeing signs that pent up demand may offset risk aversion. The takeaway from my fellow panelists and I? Expect 2023 to see companies and investors that are creative, profit-focused, and prepared to reap the benefits of this challenging moment.