M&A update: Going private

Lower rates, favourable markets drive buyouts

Dealmaking continues to show signs of momentum in the third quarter of the year as the Fed has signaled interest rates would be cut this fall following other central banks around the world. A lower rate environment and a favorable market for deal financing is expected to drive increased private equity firm buyouts of public companies as they seek to deploy their trillions of dry capital. Global merger and acquisition (M&A) activity reached over $1.8 trillion through the end of July 2024, up 14% from the same time last year.¹

While we have seen a healthy mix of strategic deals flow through the year, we are yet to see PE deals recover to their 2021-22 levels. Nevertheless there has been a notable increase in PE deals and several LBOs this year. Commentary from large U.S. private equity firms, including The Carlyle Group Inc and KKR & Co. Inc., are optimistic about M&A activity picking up into the back half of 2024. Private equity firms represented more than half of all public company acquirers in 2022, and we could see that figure exceeded in the quarters and years ahead.

The CEO and founder of Canadian technology company Nuvei Corp, which accepted a $6.3 billion offer to be acquired this spring, was recently interviewed by The Globe and Mail and gave some insights into the drivers and motivations behind his decision to go private. This included several dynamics we have previously discussed as core drivers of privatization, including the complexity, cost, and distraction of being a public company; the short-term bias impact of incentives and employee morale when tied to a share price; the challenges of managing expectations as a public company; and the steep discount in current valuations between public markets and private markets. These are common dynamics that are currently impacting numerous Canadian technology companies.

Underperformance tries investors’ patience

Of the 20 Canadian technology companies that went public on the TSX in 2020 through 2021, nine have subsequently gone private as their share prices languished.² Investor patience can wear thin with time as the businesses they own continue to underperform and trade well below their intrinsic value. Eventually seller expectations fall, or buyer expectations rise to a level where a deal can materialize. Shareholder activists can help speed up this process, forcing management and the boards’ hand to run a sales process. With small-cap valuations still at a deep discount behind large caps, many more small cap technology companies and broader small-cap businesses are likely to explore take-private transactions in the coming quarters.

Outlook

July saw a notable rotation into small caps from large caps, driving a 10.2% gain in the Russell 200, while the Nasdaq declined by 0.7%. Equity markets continued their positive streak, with the S&P 500 and S&P/TSX up 1.3% and 5.6%, bringing their year-to-date returns to 15.8% and 10.3% respectively.

With inflation, employment, and other economic data suggesting a cool-down in the economy, the market’s attention has shifted to rate-cut expectations for the year and the potential for a hard landing if rates are not cut soon enough and significantly enough. In addition to the economic uncertainty, 2024 is also ripe with political uncertainty as nearly 100 countries are expected to go to the polls this year with almost half the global population eligible to vote.³

The majority of these countries have elections that have yet to be called, adding further uncertainty to an investment environment already experiencing high volatility and geopolitical stress. With a higher probability of entering a global rate-cutting cycle, there is pent-up demand for M&A, which could be unleashed as interest rates fall.

After a strained M&A environment with two consecutive years of declining total deal value, activity in 2024 has demonstrated a sustained recovery with an improving macro backdrop. With interest rates, valuations, and economic conditions providing ample tailwinds for merger activity, we expect M&A volume to remain elevated, particularly for small and mid-cap companies.

Several holdings within our equity funds are well positioned in this environment with inexpensive valuations, several identifiable catalysts and shareholder activists which we believe makes them attractive takeover targets. The rally in small caps which started this summer still has considerable runway ahead, and many acquirers are likely to sign a deal before valuations re-rate further. This creates an ideal environment for our merger arb strategy with ample high-quality deal flow and wide spreads. We believe the non-correlated and absolute return potential for merger arbitrage should be a compelling addition to investors’ portfolios in this environment.

Notes

1. Deal Intelligence I as of August 8, 2024.
2. Sean Silcoff, “Nuvei CEO Phil Fayer on the perils of running a public tech company – and why he’s taking it private,” The Globe and Mail, Aug. 9, 2024.
3. Lucille Jones and Matthew Toole, “Deal makers hold their nerve as H2 takes off,” LSEG, Aug. 1, 2024.

Amar Pandya, CFA, is Portfolio Manager of the Pender Alternative Arbitrage Fund and the Pender Alternative Special Situations Fund at PenderFund Capital Management.

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