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Where to find opportunities amid the deal market revival

The M&A market has been on ice for a few years, but Kelli Marti, Churchill Asset Management, says we are starting to see green shoots.
Ally Selby

Livewire Markets

According to the Boston Consulting Group, the recovery in mergers and acquisitions is starting to gain momentum, but dealmakers remain cautious amid continued economic uncertainty, question marks around monetary policy and inflation, and geopolitical headwinds. 

While the global value of M&A activity was higher in the first half than this time last year, it still remains below the 10-year average. Deals involving companies in the Americas had a total value of US$647 billion, up 14% from the first half of 2023. Interestingly, 61% of overall global M&A activity occurred in North America - with a value of $631 billion. 

In comparison, deal values in the Asia Pacific region declined by 40% to an 11-year low of $117 billion. Australia's deal value declined 39% in the first half. 

It's no surprise then that Kelli Marti, of Churchill Asset Management, by Nuveen, believes we are seeing a revival in the deal market for US companies, noting the team is seeing more transactions finally come to market. 

In this episode of The Pitch, Marti shares the impact that reduced deal flow has had on the market in recent years, the positive factors she looks out for in businesses (as well as the red flags that turn her off a deal), as well as the sectors where she is seeing the most opportunity and risk today. 

    Note: This episode of The Pitch was recorded on Thursday 15 August 2024. You can watch the video or read a transcript below.

    Edited Transcript 

    Ally Selby: Hello, and welcome to The Pitch, brought to you by Livewire Markets. I'm Ally Selby, and today we're joined by Kelli Marti from Churchill to learn what's driving the revival in the deal market this year.

    Over the last few years, we've really seen a slowdown in M&A. Are there any signs that is starting to shift?

    Are we seeing a revival in deal markets? 

    Kelli Marti: Absolutely. I think it's helpful to take a step back and attribute what was causing the slowdown in M&A activity. And really, when we look at an LBO (leveraged buyout) transaction, it's typically a private equity firm selling its business to another private equity firm. The selling sponsor obviously wants to fetch the highest valuation possible, while the buying sponsor wants to pay what they view as a reasonable multiple but not overpay. 

    That delta between what we call the bid-ask really started to widen in the last couple of years. And there were a couple of reasons for that. One, is the interest rate environment. Sponsors really weren't sure, as a buying sponsor of a business, how high interest rates were going to go and how expensive the debt was going to be that they were using to finance that acquisition. As well as the macroeconomic landscape - when you're buying a business, you want to have certainty that the business is going to perform according to your projections. That was a little bit harder to predict given the macroeconomic climate.

    So really, both of those variables have been taken off the table. The interest rate environment is very clear. SOFR has maxed at where it is right now. There are expected to be rate cuts, even as soon as this year, and certainly into next year. So the interest rate environment has much more clarity, and the macroeconomic landscape, at least in the United States, has really kind of resolved into a soft landing scenario. We aren't really seeing massive headwinds from a macroeconomic environment. So with those two variables off the table, buyers and sellers are starting to find a more middle point in that bid-asked spread. So we're starting to see more transactions come to market.

    Ally Selby: Have you seen firms holding onto assets longer than they historically would, and is there any impact from that?

    The impact of reduced deal flow

    Kelli Marti: Definitely. So, as a selling sponsor, if you're going to go to market with a particular asset and you can't get the valuation that you think is deserved, you will hold that asset longer. Typically, private equity firms are looking to buy businesses, professionalise them, give operational expertise to the management team, and then sell that business in three to five years.

    What's happened in this environment, because buying and selling sponsors aren't really having that meeting in the middle, selling sponsors are holding onto their businesses quite a bit longer - five, six, even seven years. And we're seeing a new trend in the market where sponsors are selling those assets into continuation vehicles, which are also owned by the same sponsor, but allow a slight shift in ownership while still maintaining control of the business.

    Ally Selby: What does that mean for investors, that new structure?

    Kelli Marti: So, from an investor perspective, if you're investing with an asset manager and that asset manager is having trouble finding deal opportunities because the LBO environment is a little bit slower, they're going to have trouble deploying capital. And that's why it's really important when you're seeking an asset manager to understand that asset manager's sourcing capabilities.

    At Churchill, we have a unique sourcing capability in that we're investing directly in private equity funds, and that in turn drives very consistent and robust deal flow for us. So all the deals that come to market, we are able to see, and that allows us to maintain very high selectivity for the assets that we eventually underwrite in finance.

    Ally Selby: If we are seeing this revival in the deal market, where are you seeing the most opportunity today?

    Factors that are important in deal opportunities and top sectors   

    Kelli Marti: Yeah, it's a great question. And really, it comes down to what characteristics we like to see in our underlying borrowers. And there are several characteristics that we look for in a business that we choose to finance. The first one is a lack of cyclicality. It's very difficult to get comfortable with a business that's going to exhibit cyclical patterns in its revenue and cash flow.

    Another characteristic we like to see is strong historical financial performance. We want to see a long-term track record with that borrower, have they performed during different market environments? We like to underwrite a very strong management team, as well as sponsor-ownership is very important to us as well. And finally, cash flow conversion. When we're levering these businesses, it's important to see that the cash flow characteristics of the business are able to finance the debt that we're putting on that business. We spend a lot of time assessing that.

    So really, those are the characteristics of the types of businesses that we look for, and the types of industries that fit those characteristics are primarily business services. That's our largest industry category that we're investing in today, because those types of businesses exhibit those characteristics that I just talked about.

    Another industry would be healthcare. Healthcare is obviously non-cyclical. The demand drivers continue to exist despite cyclical patterns. So we tend to invest quite a bit in healthcare. Another industry I would say is software-as-a-service. Again, these are middle-market companies that we're underwriting, but we do find a lot of attractive opportunities in middle-market software-as-a-service businesses. So those are three primary categories of industries that we're seeking.

    Red flags in businesses and sectors Churchill typically avoids 

    Ally Selby: Where are you seeing the most risk today?

    Kelli Marti: So again, it's going to be based on the cash flow characteristics of the business and the cyclical patterns. So if we see a business opportunity that has distinct cyclical risk, we're definitely going to take pencils down on that, because that's very difficult to get comfortable with in this environment.

    Ally Selby: Would that be like a mining or a resources company, or a financial company?

    Kelli Marti: It could. Certainly any of those. Anything in the industry segment is very difficult for us to ever get comfortable with, so we tend to avoid the energy sector altogether. Another area would be retail or restaurants because what you see in those businesses is there's a very high need to spend CapEx. So specifically in restaurants and retail, really every dollar those businesses are earning, they have to redeploy that money to build new restaurants, new stores, or refurbish existing stores. So the cash flow conversion that we look for doesn't tend to exist in those types of businesses.

    Ally Selby: Well, thank you so much for your time today, Kelli. It was great to feature you on The Pitch. If you enjoyed that too, don't forget to subscribe to Livewire's YouTube channel. We're adding so much great content just like this every single week. 

    Learn more about the Nuveen Churchill Private Credit Income Fund here. 

    ........
    This information has been prepared for use only by wholesale clients (as defined under the Corporations Act 2001 (Cth)) by Nuveen Australia Limited (ABN 981.686.90444) (AFSL 460770). The statements contained herein represent the views and opinions of Nuveen as of the August 15, 2024 and may change without notice at any time based on market and/or other conditions and may not come to pass. All investments carry a certain degree of risk, including possible loss of principal, and there is no assurance that an investment will provide positive performance over any period of time. Past performance does not guarantee future results. Investments in middle market loans are subject to certain risks such as: credit, limited liquidity, interest rate, currency, prepayment and extension, inflation, and risk of capital loss. Private equity and private debt investments, like alternative investments are not suitable for all investors given they are speculative, subject to substantial risks including the risks associated with limited liquidity, the potential use of leverage, potential short sales, concentrated investments and may involve complex tax structures and investment strategies. Video was filmed on August 15, 2024 Featured Speaker: Kelli Marti, Senior Managing Director and Portfolio Investment Strategist at Churchill Asset Management. Churchill Asset Management is a registered investment adviser and affiliate of Nuveen, LLC Notice 9:49 GVD-3806050PF-E0824W Livewire gives readers access to information and educational content provided by financial services professionals and companies (“Livewire Contributors”). Livewire does not operate under an Australian financial services licence and relies on the exemption available under section 911A(2)(eb) of the Corporations Act 2001 (Cth) in respect of any advice given. Any advice on this site is general in nature and does not take into consideration your objectives, financial situation or needs. Before making a decision please consider these and any relevant Product Disclosure Statement. Livewire has commercial relationships with some Livewire Contributors.
    Ally Selby
    Ally Selby
    Deputy Managing Editor
    Livewire Markets

    Ally Selby is the deputy managing editor at Livewire Markets, joining the team at the end of 2020. She loves all things investing, financial literacy and content creation, having previously worked for the likes of Financial Standard, Pedestrian...

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