TITLE: Raise Capital When You Can: Guidance for Mid-Caps
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Evan Junek: I’m Evan Junek from JPMorgan’s corporate finance advisory team, and I’m excited to welcome John Richert, head of regional investment banking here at J.P. Morgan. John, welcome.
John Richert: Evan, how are you today?
Evan Junek: Doing very well, thank you. Let’s jump right into it. Can you maybe tell us a little bit about yourself? What’s your background? And how did you get to JP Morgan?
John Richert: I was the accidental investment banker, is how I like to think about it. I was an economics and French major, and I thought I would go on to be a European economist and live a life of academia. But I did a summer internship in investment banking in college, and what I really enjoyed was working with clients and becoming a problem-solver with them, whether it’s raising capital markets or on the M&A side. So post-graduation, went back into investment banking, worked at a couple of firms, and then what really became a lot of fun for me was when JPMorgan reached out to talk about building a regional investment bank, which offered me the opportunity to go be an entrepreneur and build a business from scratch inside an amazing organization like J.P. Morgan. I was impressed that they had the foresight to think about focusing on the middle-market space. They had done a really good job building out their large cap presence, and here was an opportunity to build something that they hadn’t done before, which we have been very successful at over the last 10 years.
Evan Junek: John, tell us about the regional investment bank.
John Richert: Traditionally, J.P. Morgan had always been a preeminent investment bank and advisory platform to large cap companies and large cap sponsors and large families, but we have this amazing commercial bank, which is full of middle-market companies that we really weren’t spending time with. So, the thought was let’s create a dedicated IB presence to deliver the firm with an exclusive focus on our middle-market clients, which we loosely define as below $2 billion in enterprise value. We work in continuous conjunction with our industry coverage partners as well as our commercial banking partners across the country with a very targeted approach to delivering everything that the bank has to this client base.
Evan Junek: That’s really interesting. Is it fair to say that the objective of your team is really to bring all the power and skill and capabilities of the entire organization to bear on this unique client set?
John Richert: Yeah, it is. Look, we are amazing at the capital and advice that we give globally to large cap companies,. But what most people don’t realize is that we actually have the number-one market share serving companies in the below a billion dollar to $2 billion range as well from an M&A perspective. And that is something that we’ve been, again, going back to that entrepreneurial part that I like about my job, is building a team from scratch with over a billion in revenue in this marketplace has been a ton of fun.
Oftentimes when you’re selling a business for a company that’s privately owned, this is 90%, 95% of an individual’s net worth, and they are relying on you to get them to the place where they want to be from a monetization standpoint. It’s incredibly rewarding.
Evan Junek: Let’s shift gears a little bit to the current market backdrop: lots of uncertainty out there today. What are the most significant challenges facing your clients, and how are you advising them today?
John Richert: Every time I go sit and talk to any client, public or private, we always start the conversation with supply chain… Are you seeing any improvement in supply chain? The answer tends to be, “Not yet, but it’s getting a little bit better.” The second is how do they deal with employees where it’s a combination of hard to get them and how do you think about cost, with leads us into the third point, inflation how are companies dealing with inflationary pressures. Inflation seems to be sticking quite steadily with wages for sure. So, attracting talent at wages that work from a cost structure is the third cog that we really see there.
John Richert: The second part that we see, is forecasting in a very uncertain 2023. When we’re working with companies and building out models to do valuation work, or their own internal model-building and forecasting, it’s very difficult to think about what is the cycle going to be. Companies are finding it difficult to really think about a three and five-year forecast with that environment.
Then the last bucket right now that everyone’s concerned about is raising capital, with interest rates where they have gone, with the syndicated market effectively being closed for most of the year due to the overabundance of LBO bridge book commitments that are full across Wall Street, trying to get that debt priced through the system has just led to a logjam. So, people have moved to the bank market and doing direct lending in the private market or just bilateral loans with banks, and having to think about the most effective way to raise capital has been a challenge for many companies, which goes back to the old axiom, “Raise capital when you can, not when you have to,” is something that we keep reminding our clients about. There are always windows of opportunity, so it’s, “Get ready, raise capital when you can.”
Evan Junek: John, you talked a lot about your clients generally, but are there specific considerations with respect to private companies that you would note?
John Richert: Private companies have seen a realization that things can go sideways quickly, and the conversation always now move to, “Hey, look, I had this great business, I had a massive fluctuation during COVID, now I’ve got tough issues that are happening through supply chain and a uncertain future with a recession potentially coming. I’ve built a great business “Should I start to think about monetization whether fully or partially to de-risk my own personal portfolios?” Again, 95% to a hundred percent of many individuals’ net worth is tied up in a business, so we’re having a really rapidly increasing dialogue about monetization once the market starts to normalize into the coming months and next year.
Then on the public company side, the real conversation right now is it’s tough to be a mid-cap company. If you see where the equity indexes have performed, the S&P 500 versus the Russell 2000, these middle-market companies are being stuck in this quagmire of it’s hard for them to attract long-only funds who need the liquidity to be able to go in and go out of a stock. So, you end up finding yourself much more full of hedge funds in these public companies, which increases the volatility within the share prices, and they tend to get whipsawed around at a much higher beta than the large cap companies.
So, here the conversation has been, “All right, it’s difficult to raise money to go out and do acquisitions right now. Therefore, maybe I should be thinking about a relative value trade.” The boards like to look at their 52-week highs and say, “Hey, look what I was once valued at.” Well, that was in a all-time peak of the market when we were flush with money from the Fed. Now that that’s gone away, these valuation levels might not be there. So, as opposed to talking about where we were within the last 52 weeks, the conversation amongst CEOs and boards is, “All right, how am I relatively valued to a company that makes sense to potentially merge with?” And you’re seeing a lot of MOEs similar to the one that we did earlier this year with SWM and Neenah, in the advanced material space where you took two businesses who both needed more scale and scope, put them together, and are able to take cost out of the business, increased product line, increase attractiveness to the investor universe.
Evan Junek: Yeah. John, you talked a little bit about the relative value between large caps and small caps. Interestingly enough, as I’ve looked at that data, that is actually a trend that’s changed over time. Can you talk a little bit about why today is different with respect to the perceived valuation of large cap versus small cap firms?
John Richert: The reason why you’re seeing that four-turn differential is a view of risk by the investor base, and it’s that these mid-cap companies don’t have the balance sheet, don’t have the scale, to be able to handle a longer or a prolonged recessionary environment that we could be going into. The scale and scope gives you the ability to handle rough times more than a smaller company does.
Evan Junek: The other way I’ve seen that articulated by the way is in margins, which will show you effectively the same exact picture, and when you start the conversation year-around inflation, those who are most able to weather inflation are those with the strongest margins to begin with, and that’s almost universally those with greater size, scale and diversification, who have the wherewithal to enhance margins and can leverage their scale accordingly to do so.
John Richert: Correct. And there’s a bet by investors that these margins that got so expanded in the COVID environment, like automotive retailers for example, the AutoNation, the Group 1s of the world, they had this pop in pricing because supply was so small Margins inflated tremendously, but as things normalize that’s going to compress just as quickly. So, investors have gotten ahead of that, and that’s why you see multiples coming down.
I think the one thing that would probably surprise people the most is, the world has certainly changed in the last 12 months, but we are actually starting to see a robust building pipeline of deal flow in companies that are willing to transact. Buyers adjusted their view of multiples much quicker than sellers do, which is normal. Sellers tend to look historically at, “Here’s the multiples that people paid, these are the transaction comps over the last 12, 24, 36 months. I want that,” because everybody thinks they’re the best looking car on the lot, to use a metaphor. But they have now started to understand that those multiples are probably not coming back for quite some time.
So, I would classify it as companies are now starting to think about a transaction. It’s a more balanced environment between buyers and sellers versus the frenzied buyer landscape over the last two years.
Evan Junek: John, tell us a little bit about the macro environment and how that’s impacting your clients.
John Richert: With the macroeconomic headwinds and uncertainty, it’ll be imperative for companies to navigate this environment profitably in order to command buyer attention.
Once markets stabilize from a financing standpoint, it’s a good time to get back into the market and look to monetize either a family or privately-owned business or private equity looking to get exits out. I think the IPO markets may be a bit more uncertain than the M&A markets in ’23 and ’24, so I think you’ll see a pickup in M&A on a year-over-year basis while the IPO markets I think will be substantially closed into the back half of next year, if not the beginning of 2024. The surprise is there is going to be, in our opinion, pretty good M&A activity in 2023 despite all the noise we’ve talked about.
Evan Junek: Those points take me to my next question, which is really, what do you see as the primary themes for 2023 for your clients in your space?
John Richert: I think there was so much refi activity that was done in 2020 and 2021, even 2019.
Evan Junek: Debt refinancing activity.
John Richert: … exactly, that there’s not really a maturity cliff in 2023 or early 2024. So, people are not going to be forced to refinance in 2023, but they’re going to be keeping a really close eye on the market, that if there are windows of opportunity to go ahead and start to push out ’25 and ’26 maturities, I think that’ll be light in 2023, but it’ll really accelerate going into 2024. Again, I think the equity markets are going to be challenged still in 2023, but as we talked about, I think the M&A markets are actually going to be okay, and I would expect an uptick on activity over 2022.
Evan Junek: And you think that’s biased towards strategic or financial sponsor activity as well?
John Richert: It’s two things. One, strategic is still looking for scale. Most of the bake-offs that we’ve participated in in the last, let’s call it four to six weeks, have been, “Here’s the strategics that really need to increase scale or product line that they don’t have.” That’s why they’re going to be looking at this across tech, industrial and healthcare. I think those would be three very strong areas.
Then from the sponsor standpoint, their whole goal is monetizing, putting money to work, and they did not put much money to work in 2022. There’s been a lot of funds that raise money in 2021 and 2022 who need to get putting that to work in 2023, and with multiples coming down, it’s an easier entry point for them assuming they can solve for the debt equation. If they can’t, I think you’ll see what you’ve noticed on a couple of the recent sponsor deals where it’s an over equitization of an acquisition, if the viewpoint is, “Eventually the debt markets will get great, and I’ll just right-size the capital stack with the appropriate amount of debt once the markets are back to normal.” But they are having the calculus right now of what was single-Bs getting priced in that 5% to 6% range, that’s now 9% to 10%. So, the calculus is different for private equity right now.
Evan Junek: Clearly, a big part of some of that outlook is the interest rate dynamic, right?
John Richert: Mm-hmm.
Evan Junek: You alluded to that I think in a couple different points throughout. Suffice it to say, would you agree with the statement that if we have materially lower rates next year, that’s going to fundamentally probably change the way in which some of those forecasts, or your perspectives on the themes that would emerge next year, is that a fair statement? Maybe put differently, there’s a lot of pent-up demand for doing financing potentially-
John Richert: Correct.
Evan Junek: If I was sitting in the shoes of a family founder or a business owner today thinking about taking the step of monetizing my business, I think a natural concern would be, “Is now really the right time to sell?” I was wondering if you could just talk a little bit about some of the tools in the toolbox that you discuss with those kinds of family owners to mitigate, well, just point-in-time value risk, whether that be some form of contingent value, whether that be taking shares.
John Richert: Well, I’ll give you an example. A founder of a business had an offer this year then geopolitical challenges caused by the events in the Ukraine and things went on hold.
He has been approached again, so conversations can go like this “Look, you don’t have to sell a hundred percent of your company. Why don’t you at this point sell 50 to 75% of it? You maintain a material stake in the business, you structure the transaction such that you still have control of the business, and you now will structure also a put-call mechanism in that business that in four or five years when hopefully the market has normalized again, that remaining 50% to 25% of the company that you didn’t sell, you can now monetize that at a higher multiple than you did the first half.”
Evan Junek: Makes complete sense. People wanting to de-risk, manage through the uncertain market backdrop, but at the same time don’t want to be in a place where a year or two down the line you’re looking back regretting selling the whole farm for the wrong price.
John Richert: Correct.
Evan Junek: John, thanks so much for joining me today. I really appreciate the perspectives you had to offer, and really a great conversation.
John Richert: Evan, always good to catch up with you, and I appreciate you taking the time as well.
Evan Junek: Thanks, John.
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