One note to start: We made it to 2023. In this special edition of DD, we’re forecasting the biggest themes that will affect M&A, private equity, corporate finance and much more in the coming months. Before you dive in, here’s our wrap of last year’s dealmaking.
We’ll be back to our regularly scheduled programming on Tuesday, January 10. Thanks for reading and happy new year from Arash, JFK and the whole DD crew.
Welcome to Due Diligence, your briefing on dealmaking, private equity and corporate finance. This article is an on-site version of the newsletter. Sign up here to get the newsletter sent to your inbox every Tuesday to Friday. Get in touch with us anytime: [email protected]
1. Will investors get serious about due diligence?
“You don’t find out who’s been swimming naked until the tide goes out,” Warren Buffett famously said.
Sure enough, plunging markets in 2022 led to high-profile implosions at a number of supposedly sure-fire growth companies. The collapses spurred a reckoning over the extent to which reality and due diligence fell by the wayside during the pandemic bull market.
The face of the pandemic tech boom may well have been Chase Coleman’s hedge fund Tiger Global Management, which lost billions holding shares in public and private tech companies at peak valuations. His firm’s flagship fund lost more than half its value year to date through to the end of October, while a “crossover” fund that mixes public and private positions dropped 44 per cent year to date through to the end of October.
Over at SoftBank, we revealed that Masayoshi Son’s investments are going so badly that the founder personally owes the company about $5bn.
Tiger, like SoftBank and Sequoia Capital, invested in Sam Bankman-Fried’s collapsed crypto exchange FTX, losing about $30mn.
FTX’s collapse into bankruptcy — after raising money in January 2022 at a $32bn valuation — has led to criminal charges against SBF and its top leadership, who several weeks ago admitted to the misuse of FTX customer funds. The fiasco has further chipped away at what fragile confidence remains in the crypto sector, where a number of firms went bust in 2022. (Lawyers, at least, are cashing in on the chaos.)
It also raised questions about how seriously venture capitalists were vetting their deals. In November, Sequoia wrote its $210mn investment in FTX down to zero and deleted a lengthy hagiography of the FTX boss from its website. While the firm apologised for the deal and defended its investment screening, the episode reverberated through the venture capital industry.
No single transaction better reflected the carelessness with which dealmaking was pursued last year than Elon Musk’s rollercoaster acquisition of Twitter for $44bn in April. Musk, whose bravado led him to waive due diligence during the deal negotiations, spent months trying and failing to back out of an iron-tight merger agreement.
On the hook are banks including Morgan Stanley, Bank of America and Barclays who wrote multibillion-dollar cheques to fund the deal and are struggling to offload the debt. Equity investors, alongside Musk, once again embarrassingly included Sequoia.
Now as Twitter strains under its debt and Musk’s chaotic leadership, attention has shifted to Tesla, the car company responsible for most of Musk’s wealth but not much of his attention these days. Shares in the company fell by more than 65 per cent in 2022.
2. Can the Fed get a handle on the market?
If there’s someone to thank for the dour year on Wall Street, it is Jay Powell.
The Federal Reserve chair’s push to tame inflation and restore price stability sent shockwaves through financial markets. Credit markets slammed shut and initial public offerings were postponed as more than a decade of easy money came to a close. Investment banking fees are down more than a third from 2021’s record level, Refinitiv data show.
Whether Wall Street can find its footing in 2023 will depend largely on whether Powell believes he needs to continue to tighten the screws.
Without clarity, risk committees at most major banks remain unwilling to provide the kind of leverage that private equity funds need to make most large-scale buyouts work.
Instead dealmakers are requiring larger equity cheques from buyout shops before underwriting debt. At the same time, there have been a rush of minority-stake transactions so private equity buyers avoid having to tap debt markets.
Questions also remain over the capacity of the big private lenders that have taken the place of banks. The slow fundraising environment has led many private credit funds to focus on existing loans, writing smaller cheques and being pickier about which deals they back.
Bankers tell DD that they don’t necessarily need the Fed to cut rates before they open their purse strings. It’s stability in the market that they’re after, which would give them the confidence to commit to debt packages at terms that don’t make buyouts uneconomical. Unfortunately for those waiting, it’s not yet clear Powell is ready to flash the green light.
3. Is private equity in the danger zone?
The past decade has been kind to the private equity industry. But the free-money era is over, and cracks are starting to show.
Blackstone’s decision to limit withdrawals from its $69bn real estate investment fund this month, after a surge in redemption requests from its wealthy clients, is one sign of that.
Raising funds from institutions is getting harder too. Carlyle has said it expects to miss the deadline to raise a $22bn flagship fund by March (it had raised just $14bn by September 30, corporate filings show) and Apollo said last month that it would take longer than anticipated to raise its latest buyout fund.
Companies that were bought with hefty leverage at eye-watering valuations in the past few years look particularly vulnerable to a protracted downturn.
Still, many private equity firms have not yet marked down the value of their portfolio companies anywhere near tumbling valuations on public markets.
Some of the companies that private equity took public during better times have fallen hard, erasing billions of dollars in value. Shares in Oatly, in which Blackstone has a 6.7 per cent stake, once traded at over $28 but are now under $2. Olaplex, the premium shampoo business taken public by Advent International, has been trading at about $5, down from highs of more than $29.
There’s a major difference between private equity today and during the 2008 crisis. Back then, investors mostly continued to meet capital calls from the buyout funds they had committed to. Their main problem was disappointing returns — what the industry euphemistically calls a “bad vintage”.
This time, layers upon layers of leverage have been built into the system. Not only do portfolio companies carry debt; the funds that own them do as well.
Some investors have leveraged their commitments to buyout funds. Then there are subscription lines, net asset value loans and fund-level preferred equity, as the FT’s Helen Thomas explains. On top of that are “collateralised fund obligations”, a private equity variant of the collateralised debt obligations that only became widely understood after they wreaked havoc during the financial crisis.
Much of this market operates behind closed doors, with little public disclosure, making it difficult to assess the risks. But there are signs of a retreat. Citigroup said in September it was dramatically scaling back its subscription-line financing business.
As a liquidity crunch looks set to be one of 2023’s big financial stories, the buyouts business is starting on difficult ground.
4. How bad are the lay-offs going to be on Wall Street?
No one delivers the holiday spirit quite like David Solomon.
In an effort to boost its share price and combat a drop-off in dealmaking and capital markets activity compared to a bumper 2021, the Goldman Sachs boss is preparing for a round of lay-offs in the first half of January. Managers were asked to identify staff to be made redundant before the end of 2022.
“I’m dreading the conversations I’m going to have with my team,” one seasoned Goldman banker told the FT.
That’s after the US lender slashed the bonus pool for its 3,000 investment bankers by 40 per cent or more, the biggest drop since the 2008 financial crisis. Goldman’s roughly 400 partners took the hardest hits.
The pain is being felt from Wall Street to the City to Silicon Valley to the realm of professional services. It goes without saying that the crypto crowd has also fallen upon hard times — much to the dismay of Miami nightclub owners.
Banks still generated about $104bn in 2022, 16 per cent above the average of the past 20 years despite the sharp decline in fees from 2021.
“The backlog remains so strong that the investment banks need to have an eye toward retention for likely future activity,” Wells Fargo analyst Mike Mayo told DD’s James Fontanella-Khan.
The cuts herald a return to normality rather than something more ominous, said several analysts and veteran bankers. The same can be said for tech, where mass lay-offs offer a cautionary tale of what happens when talent wars rage for too long. (That’s excluding the employee exodus at Twitter, which is an entirely different story.)
A down economy is, however, good news for one group: the lawyers and bankers who specialise in restructuring.
Fitch, the ratings agency, says that default rates for junk bonds and leveraged loans in 2023 could reach about 3 per cent. That would be a sharp increase from 2021 lows.
Disclosures in the 2022 bankruptcies of companies such as Revlon and FTX reveal that top bankruptcy lawyers are billing more than $2,000 per hour for their services. Going bust is never cheap.
5. How far will the ‘trustbusters’ go to curb private equity power?
Joe Biden’s new brigade of antitrust officials was meant to crack down on tech giants such as Google, Meta and Amazon. So far, however, they’ve struggled to leave a mark.
That’s why US Federal Trade Commission chair Lina Khan and Jonathan Kanter, who heads the Department of Justice’s antitrust unit, are likely to double down on a less obvious target: private equity giants.
The rise of buyout groups over the past 50 years has become impossible for antitrust regulators to ignore. They have started probing the way those firms accumulate and exercise power over vast portions of the US economy. A prime example is the influence big private equity players have on the healthcare sector, as DD’s Mark Vandevelde reports.
Team DD and the FT’s competition reporter Stefania Palma have been focusing on this for months as part of a series on “Trustbusters vs private equity”.
Private equity titans have long believed there was little jurisprudence to support a case that buyout firms were acting in an anti-competitive manner. However, Khan and Kanter are going after the way private equity executives control companies in similar sectors by sitting on their boards.
Seven private equity executives, including a partner at software-focused buyout mega-player Thoma Bravo, stepped down from boards of companies their funds owned in October after the DoJ warned they were violating antitrust laws.
More broadly, many of the dealmakers who spoke with DD said one of their biggest concerns for 2023 is a regulatory crackdown. Several deals, including Microsoft’s blockbuster $75bn agreement to buy Activision Blizzard and Kroger’s near $25bn acquisition of rival Albertsons, are under scrutiny.
For more on what these trustbusters are doing, check out Stefania’s excellent video explainer.
And finally, we’re looking back on some of our favourite features from last year:
The private equity club: how corporate raiders became teams of rivals
Carlyle: the buyout pioneer in need of a CEO
Inside Masa Son’s $5bn SoftBank IOU
How the Morrisons buyout turned into a nightmare for Goldman Sachs
Women spoke up, men cried conspiracy: inside Axel Springer’s #MeToo moment
CVC’s biggest bet yet: the fiercely private buyout firm set to go public
How Wall Street stormed the music business
Selling to yourself: the private equity groups that buy companies they own
Collateralised fund obligations: how private equity securitised itself
How Oaktree captured Evergrande’s castle
Masayoshi Son and Marcelo Claure: inside the expensive divorce at SoftBank
Elon Musk rallies wealthy friends and true believers to his side on Twitter deal
Rocco Commisso bought a football club. Then the trouble started
Poison, planes and Putin: Abramovich’s race to save a fortune and stop the war
‘Not my yacht’ — how murky structures cloud ownership of oligarch toys
AC Milan’s new owners bet they can top miracle season
Recommended newsletters for you
Cryptofinance — Scott Chipolina filters out the noise of the global cryptocurrency industry. Sign up here
The Lex Newsletter — Catch up with a letter from Lex’s centres around the world each Wednesday, and a review of the week’s best commentary every Friday. Sign up here