What if you got a glimpse into the future, and what you saw terrified you? You’d likely take action to improve your fate.
That may sound like Charles Dickens’ “A Christmas Carol,” but we’re talking about the 2019 mergers-and-acquisitions market.
As Larry Grafstein, the deputy chairman of global investment banking at RBC Capital Markets, tells it, business leaders in December 2018 got a frightening peek at what the next financial crisis or recession might look like — and for some it startled them into a renewed sense of urgency.
After Federal Reserve Chairman Jerome Powell signaled last October that the Fed’s tightening plan was full speed ahead, markets got jittery, feeling it was too much too soon for the American economy. And by December, after the Fed hiked rates further and signaled two more rate bumps for 2019, markets hit a free fall that left most indexes in correction territory.
M&A, which was scorching for most of 2018, also went cold — the $553 billion in global deal volume in Q4 was the lowest tally since the first quarter of 2014, according to Bloomberg data — and the malaise carried over into the new year.
The pivot quickly soothed volatile markets, and business leaders who may have been mulling selling a company or going public suddenly got another opportunity to do so in near-peak economic conditions.
“We think that it has actually on the margin made sellers more likely to sell, because they had a window into what a severe market correction might look like and feel like,” Grafstein told Business Insider in a recent interview.
Grafstein and RBC are happy to capitalize on the resurrected dealmaking enthusiasm. The bank, which is 10 years into its US investment-banking push, poached Grafstein from UBS last summer and has brought on a slew of other veteran dealmakers since — including Asad Kazim, a top real-estate banker also from UBS, and Andrew Callaway, who was hired from Bank of America Merrill Lynch in January to run healthcare investment banking.
RBC has already landed a lead role on one of the largest megadeals of the year: the $66 billion merger of BB&T and SunTrust.
In a recent interview with Business Insider, Grafstein spoke more about the surprising turnaround in the investment-banking outlook for 2019, why that may spur action from unicorns and sellers, the biggest concern among executives and board members right now, how Republican tax reform may have stimulated more capital investment than people anticipated, and why the veteran dealmaker decided to make the jump to RBC.
Interview condensed and edited for clarity.
How is business going in 2019, and how did things rebound from the slowdown at the end of last year?
The fourth quarter of 2018, we had obviously a change in the markets, and it was both rapid and significant.
We saw particularly in December the indexes close to bear market, 20% off their highs. I think what was notable about that in 2018 was you couldn’t help but have people concerned about the outlook for the economy in general, but obviously mergers in particular.
And yet, in January, we had a fairly rapid pivot by the Fed and a turnaround in the market. So as we look now at 2019 and the outlook as we sit here today in March, it feels like more of the same. In other words: strong equity valuations and high levels of M&A activity.
One of the notable things about the rapidity and severity of the market correction in the fourth quarter was that it gave people a glimpse of what might happen if we entered into a slowdown after many years of robust conditions. And that had a psychological impact, not just an economic impact.
The Fed keeping interest-rate increases modest and also saying it was not going to quantitatively tighten as much as maybe people expected created a baseline. But the psychology of seeing the markets turn, we think — talking to our clients — created a little bit of stimulation of people to say, “We don’t necessarily want to miss a window to sell.”
When you head into market conditions like that, which can last for longer than a few weeks, which happened this time, people say, “I don’t want to get trapped.” And so we think that it has actually on the margin made sellers more likely to sell, because they had a window into what a severe market correction might look like and feel like.
Now at the same time, valuations — which you always think about value corrections as being opportunities — the fact that we had a very brief correction in the public markets meant that we haven’t really seen multiple compression in the private markets. Deals are still being done at close to peak multiples if not peak multiples.
But generally, it’s safe to say on the margin, people that might’ve wanted to hold out for every last penny are now willing to pull the trigger and sell.
On the margin, people that might’ve wanted to hold out for every last penny are now willing to pull the trigger and sell.
Getting into the psychology a little bit more: People get a glimpse of what could be a dismal future if we’re heading into a recession, and then it pulls back. And that’s contributing to people saying, “Well look, I’ve got a second opportunity now to take some action”?
Exactly. I think that affects obviously the M&A markets, and it affects also the equity markets. We’re about to see a wave of major private companies, so-called unicorns, go public. And clearly, the experience of the market break in December coupled with the normalization in January, prior to what could be a volatile and turbulent election year in 2020, means that people understand this is a good window to consider issuing equity, or selling a company, or both.
Among the clients you talk to, was the Fed pivot unusual in terms of the reaction to it?
People are always monitoring interest rates. Treasurers in particular are always trying to issue debt opportunistically. And CEOs are focused, as you would expect, on confidence and the secular tailwinds in the economy. So you can’t help notice when you have a market event like that — everyone pays attention.
On the other hand, everyone also understands that regardless of any given moment today in the stock market, we’ve had a prolonged period of historically low interest rates. Even though we’ve had some encouraging numbers for overall economic growth, there’s still fragility in the global ecosystem. Some of that is driven obviously by concerns about trade with China, some of it concerns about European overall economic conditions.
For anyone with historical perspective, CEOs, finance people who have some experience, we know this is an unusually long time of benign conditions, and it’s been driven by the Fed, which is why there’s so much attention to whatever the Fed’s doing. As a result, everyone is very watchful about things.
That said, one of the encouraging things, which I mentioned to you before, is that we’ve seen a positive trend in nonresidential fixed investment — in other words, capital investment for businesses. And that was clearly one of the theses of tax reform: to stimulate people to invest more in productivity-enhancing opportunities.
The ability to expense capital from a tax perspective for a few years under tax reform is really an incentive for people to think about putting projects in place. And, many times, major capital-investment projects take a while to plan and a while to execute, so the fact that that was one of the cornerstones, I think, of what the Republicans said they wanted to do with tax reform — so you have seen a positive reaction.
And there was a concern that maybe tax reform was maybe a one-time boost to that, but the fact that nonresidential fixed investment went up in the fourth quarter — just reported last month — shows that may be a positive sign.
Even though we’ve had some encouraging numbers for overall economic growth, there’s still fragility in the global ecosystem.
So coming off of a very strong 2017 and 2018, you don’t think there’s any reason 2019 can’t live up to those standards?
Right, and I think if we were sitting here on December 20, we’d be feeling a lot different than March 20. A lot has happened in that period, but I think there’s always a little bit of a pause for people to assess what the outlook is, but I think now clearly it’s, “OK, conditions are still good.” Clearly there’s still risks out there — no one’s oblivious to the risks — but conditions continue to be solid.
When you’re talking to decision makers, executives, and board members, what’s the biggest concern going forward?
I think it is the unpredictability of what might happen if things escalate with China. And that doesn’t affect every single business, but clearly there’s a knock-on effect, even for people that are domestically focused. This era of globalization has, for better or worse, led to very complex supply chains, and when you start having tariffs and trade tension, that can upset supply chains and requires a lot of reaction and improvisation. And it also creates a bit of uncertainty, which, people never like uncertainty.
Why was this the right opportunity and the right time for you to join RBC?
RBC is a full-service investment bank in the US, which has been, I think, the fastest-growing platform since the crisis. The company has been a leader in Canada not just for 10 years but for decades, in a very competitive banking market. There’s major competition both from Canadian domestic banks and global banks within the Canadian market. RBC’s always done very well there.
What we find as I talk to clients out there — and I knew this before I came — is that it is one of the banks that both leading private-equity investors and leading corporations want to have an institutional relationship with. Because it’s stable, it’s been here for a long period of time, and it’s committed to this market.
I think if you look at the track record of how RBC Capital Markets has been built in the US the last nine or 10 years, it’s been cautious but consistent. And I think that’s a very good formula for growing in what is a volatile and challenging industry.