Corporate Finance in particular M&A as the „Crowning discipline“ has been criticized by it´s social uselessness and whether it contributes to the common wealth. Dr. Martin Reitz, Member of the Group Executive Comittee, Rothshild & Co answers the question why and how investment banking is playing an essential role in the international economic tapestry by analyzing on the changes and leveraging for capital and corporate control.
Corporate Finance, in particular Mergers and Acquisitions (M&A), is often called the “crowning discipline” of Investment Banking. This is not surprising. Nowhere else are banks so closely involved in the execution and implementation of the most significant, and often most transforming, strategic projects for their corporate clients. Corporate finance transactions regularly appear on the front pages of our daily newspapers, and they inspire the imagination of the general public in relation to what happens in the economy. Today, not only most companies, but also wealthy families, global institutional investors, and a large number of governments around the world regularly use the services of investment banks to execute their economic strategies and to manage transactions in global capital markets.
However, the reputation of Investment Banking has been mixed recently. In the aftermath of the financial crisis, many people have started to question its social usefulness and whether it contributes to the common good. Applications for analyst positions in the banking industry have underperformed those for other industries. And whilst most of the scepticism is related to the sales and trading side of the investment banking industry, the advisory side is also not immune to a critical perspective, as shown for example by the regular controversy about whether M&A and the related financing activities generate any value.
Responding to and affecting lasting change
At the same time, we are seeing a lot of activity in mergers and acquisitions as well as financing globally. M&A volumes have doubled post financial crisis and amount to around 4 trillion US$ combined transaction value per annum in 2018 and 2019, with no slowdown currently in sight. The total number of transactions, 2019 at 40.000 deals worldwide, is up by 25% compared to the year 2009. This is in part a cyclical phenomenon. The level of M&A activity fluctuates with the stock market. It is easy to see why this should be the case. First, selling assets is more attractive when valuations are high, and second, leaders of businesses who act as buyers are usually more confident about the future of business (“CEO confidence”) in phases of positive stock market performance. In addition, stronger markets make it easier to get the related financing transactions done.
However, there is also structural growth. The number of transactions is growing substantially across the cycle and has almost doubled since 2002, the low point after the burst of the dot.com bubble. And the average global annual deal volumes during the current market cycle are more than 30% above those during the last cycle before the financial crisis.
The number of transactions is growing over time because a substantial part of the global deal activity is not primarily a response to the economic cycle. It is much more a reaction to innovation and globalization, to structural changes in technology, competitive industry dynamics, as well as political and regulatory developments, most of which are new, and are accelerating in scale and scope:
- The digitalization of products, services and value chains, driven by a combination of mobile internet, cloud computing and high-speed data processing
- The surge in Artificial Intelligence and robotics
- Breakthroughs in bio- and genetic technology
- A shift to clean energy and a carbon-neutral economy enforced by CO2 regulations and changing consumer preferences
- The emergence of a whole range of new, highly capable competitors in almost all traditional industries and markets – due to the steady rise of so called ‘developing world economies’
As Ian Goldin and Chris Kutarna described it in their famous book titled “Age of Discovery”, we are living in a new “renaissance”, a time of fundamental scientific and social innovation, with the potential to fundamentally reshape all our lives. These powerful innovation trends are accelerating. The corresponding transformation of many industries (like for example the retail, media, banking, machinery, utilities or automotive industries) is increasingly far-reaching and fundamental, forcing about strategic change.
Leveraging the markets for capital and corporate control
Businesses have to adapt to these changes. They are under pressure to seize new opportunities and to manage the risks. Many are faced with new and sometimes drastic challenges: an erosion of market-share due to emerging competitors, the threat that their business model may become obsolete due to technological change, or a drop in competitiveness due to intense regulation.
This creates pressure to act in order to survive. The strategic challenges are often significant. They require tailor-made answers and fast implementation. For this, the “market for corporate control”, which is the selling, merging or buying of businesses, provides a relevant and highly valuable strategic opportunity. By leveraging the M&A option at the right point in time, companies can stay ahead of the game – or in the game.
How does this work in practice? If we consider the outperformers amongst our clients or within today’s industries, they usually combine a set of structural strengths, with focus on:
- Scale (market leadership, efficiency and barriers to entry – in an increasingly digital business world where the “winner takes it all”, this aspect is becoming more and more important)
- Access to Growth (via business activities in dynamic regions and growing business segments)
- Access to Technology (to be able to drive critical innovation and to have access to leading technology)
- Access to Capital (financial firepower and risk capacity through strong balance sheet / rating)
By accessing and leveraging the market for corporate control as well as for debt and equity capital, investment banks help their clients implement strategic projects that can increase scale, provide access to growth or critical / new technology, and raise the required capital in the most efficient and strategically thoughtful way. The M&A market also offers ways to rapidly exit those parts of the business where the battle for a meaningful market position has already been lost.
Successful strategic adaption involves a critical review of a company’s own businesses against the key factors of competitiveness and long-term success. Businesses who lack critical mass, for example, should either be sold, as long as other industry participants are still in need for scale, or strengthened by active consolidation, if opportunities exist. Increasing exposure to growth by buying into fast-growing regions or new business platforms in adjacent businesses is another way of increasing strength and creating sustainable competitive advantage. Similarly, the acquisition of critical technology assets – like in software, biotechnology, digital business models, renewable energy solutions – can substantially strengthen businesses who lack those capabilities.
All these strategic initiatives require a functioning market for corporate control. The interesting thing about this market is that a large part of it – the market for private company control – only exists when it is being actively created. By preparing an asset for sale, for example, by putting the necessary information together and by contacting those who might be interested in buying it, bankers create a marketplace where companies and investors are able to transact. This is of substantial value for clients.
From corporate control to capital, the services of investment banks hence provide companies with effective strategic tools in an environment of rapid change – and hence the chance to prosper, to grow, to defend against decline, by offering fast-track strategy execution, leveraging the full potential of global capital markets. Of course, this chance does not come without risk. In times of technological and political transformation, future business prospects are often uncertain, and change can be unexpected. The approach taken by companies regarding pre-deal risk assessment and post-deal risk management plays a critical role in determining the long-term success of their strategic projects.
Investment banks play an essential role in the international economic tapestry. Their services are a key ingredient in the dynamic adjustment of companies and industries. Investment banks are ultimately change agents: they help their clients utilize and leverage important capital markets. With the service of investment banks, companies have a wide range of options to implement their strategic plan for sustainable success in a fast-changing world.