Why Accelerated Share Repurchasing Is on the Rise

Actionable Ideas for Companies and Sponsors

Recent volatility in the equity markets is driving a record pace of share repurchase activity. Companies evaluating a share buyback, often look to signal confidence in their business and balance sheet through an Accelerated Share Repurchase (ASR). The increased volatility also makes ASRs more attractive from a pricing perspective given the resulting higher discount on the repurchase price.

We are also seeing share repurchases in connection with insider sell downs, especially from sponsors. Over the past year, more than 30% of sponsor sell-downs in the U.S. were coupled with a share repurchase from the company. The concurrent repurchase has proven to be an efficient way to enhance the size or pricing of a secondary share offering in an otherwise challenging market. On average, blocks with a share repurchase have priced at tighter discounts and traded better in the aftermarket.

We expect share repurchase and ASR activity to remain robust throughout the year and Jefferies has unique insights into these execution strategies.

Prime Services C-Suite Newsletter – May 2023

Top of Mind: SEC, Outsourcing, Talent, and Technology

Our monthly newsletter for multi-hat-wearing C-suite leaders covers the latest and greatest insights across the hedge fund industry.

Progress Check on Emerging Markets

What Happens as Developing Markets Develop?

The world is going through a transitional period, and investors are revisiting their views of and exposure to emerging markets. There has been considerable change in the last decade, with geopolitical shifts, Covid closures, and emerging opportunities.  Whether it’s the rise of the Middle East, India’s population growth outpacing China, or China evolving into its own category – topics of discussion are endless. Progress Check on Emerging Markets unpacks latest investor sentiment and areas of interest in these rapidly shifting asset classes.

Actionable Ideas: Navigating Volatility with Stock-for-Stock Transactions

Actionable Ideas for Companies and Sponsors

The M&A market remains challenged by dislocation relating to the failure of SVB and the continuing overhang of interest rate uncertainty, the possibility of recession and ongoing geopolitical tensions extending from the Russia/Ukraine conflict to China and North Korea. Any one of these factors alone would have a negative impact on M&A, and this cocktail of concerns has substantially dampened activity; the volume of announced transactions in January 2023 was the lowest in two decades and represented just one-third of the announced transactions in January 2022.

Notwithstanding these headwinds, pockets of activity and structures which can be used to mitigate risk remain. Stock-for-stock transactions remain an effective means of reducing risk and equilibrating valuations in periods of volatility. These transactions tend to take place within industries as valuations and stock prices are likely to move in sync, thus lessening multiple disparities amongst parties. Stock swaps also facilitate substantial transactions without overleveraging balance sheets, and in some cases, result in lower pro forma combined leverage. The combination of increased scale and synergies can be a powerful motivator in otherwise challenging economic conditions for corporations.

Recent examples which underscore the logic of stock-for-stock transactions include two transactions unveiled in late January and early February. In January, Xylem agreed to acquire Evoqua in a $7.5 billion transaction to create a $7.0 billion pro forma revenue company specializing in water technology and treatment. In early February, Newmont Corp made an unsolicited $16.9 billion stock-for-stock offer for Newcrest Mining. While the offer was rejected as inadequate, Newcrest agreed to provide limited non-public information to Newmont potentially to facilitate an improved proposal. These two combinations demonstrate the conviction around industry scale and importance of balance sheet strength. We expect to see more stock-for-stock transactions, albeit dominated by friendly mergers, as the year progresses.

Rights Offerings: A New Financing Tool for Distressed Company Acquisitions?

Actionable Ideas for Companies and Sponsors

The use of rights offerings has become an increasingly popular means of acquiring a company in distressed situations, including, without limitation, pursuant to a Plan of Reorganization in a Chapter 11 proceeding. Rights offering provides a debtor and participants with many benefits including (i) providing access to capital, (ii) resolving valuation disputes, (iii) allocating control, and (iv) a potential exemption from registering new securities with the SEC.

In bankruptcy, a rights offering allows a company to offer creditors or equity security holders the right to purchase equity in the post-emergence company, usually at a discount to the assumed value of the reorganized enterprise. Because the new equity is typically sold at a discount to plan value, interested parties often have a strong incentive to participate in the offering to avoid dilution. Moreover, since the capital being raised via the rights offering is necessary to fund the Plan of Reorganization, rights offerings are almost always backstopped by a third party, ensuring that the requisite capital is fully committed. Furthermore, the parties providing the backstop typically receive a fee for providing the commitment; on average, backstop fees range from 3% to 10% of the financing.

Rights offerings also have proven to be an especially effective tool for junior creditors or equity holders to support their position on the value of the debtor due to their willingness to invest new money.

Actionable Ideas: Discount Exchanges as a Deleveraging Strategy

Actionable Ideas for Companies and Sponsors

Companies with multiple tiers of debt trading at a discount to par often examine ways to repurchase the debt to capture a discount; thereby deleveraging their balance sheet.

Typically, however, these companies lack ready access to capital to fund debt buybacks. In these situations, there may be an opportunity for long-dated maturity or unsecured bondholders to exchange their debt into instruments with collateral, guarantees, shorter maturities or other enhancements to induce holders to participate in the exchange.

A contemplated discount exchange is often most effective when the issuer faces future uncertainty as to its ability to repay longer dated debt or the capital structure implies significant downside for junior or unsecured creditors in the event of a bankruptcy. In these circumstances, bondholders typically value their existing debt on a yield to workout basis; more specifically, investors estimate a future reorg value, applying the cap structure in order of payment priority and then estimating the recovery to their class. To the extent there is further downside, bondholders may act defensively, allowing issuers to exchange bonds, at a discount, with features (i.e., collateral) that provide downside protection in a reorganization in exchange for existing debt and, in doing so, incrementally reduce debt with little or no upfront cash.

Hedge Funds Continue Resilience through Market Turbulence

Shannon Murphy, Managing Director and Head of Strategic Content at Jefferies, delves into the evolving market landscape for American hedge funds. With funds overseeing a record number of assets and market-wide volatility on the rise, fund managers are confronted with an array of new challenges and opportunities. Murphy examines the industry’s potential for continued growth, emphasizing the importance of agility and adaptability amid turbulent conditions.

2023 marks a fascinating inflection point for the hedge fund industry. There are approximately 8000 hedge funds today, which is essentially the same number we had a decade ago, but they are managing nearly double the assets. This makes for a pretty competitive landscape as firms vie for that incremental dollar.

This competitive environment emerges just as our investing landscape undergoes a period of transition. Allocators are revisiting their portfolios, deciding how to position themselves for the next five to ten years. It’s a very exciting time for funds who can manage volatility across cycles. A lot of these partnerships are being renewed, refreshed, and rebuilt for the next decade.

As allocators revisit their portfolios, the industry now has a four-year track record of solid performance, outperformance, and capital protection. First, we saw three years of double digit performance, the first time that that’s happened since the late nineties. Then, last year, hedge funds protected for the best time in 15 years, all during a period when the VIX traded above its historic average 95% of trading days. These are the sort of numbers that make me really excited about new leaders on both sides of the aisle: new managers and new allocators.

As managers go back to the basics, this environment almost becomes  ‘P&L 101’. How does what you’re bringing in match what you need – not just this year, but in 2024 and 2025, too? Hedge funds can massively outperform the indices (as we saw last year), but maintaining a stable and agile business requires one to strike an appropriate balance with incentive and management fees.

Periods of transition herald a lot of opportunity. If you’re a manager that is willing to revisit your assumptions, you can create new muscle memory by adapting to a new investing regime. Every generation goes through this, and there’s a dichotomy between those who have lived through an economic transition and those for whom this is a first. It’s critical to build a strong foundation, but also build agility into your organization, your investment process, and your risk management process.

Today’s market can be summarized with one word: rates. The industry needs to remember the implications of a rising rate environment for their businesses, their portfolio companies, and counterparties. Managers must assess their competitive position and ability to invest in talent, capitalize on dislocations and opportunities, and utilize new assets, investing processes, risk management frameworks, and data sets.

We’re operating in a period of new market circumstances and strange contradictions. In just the first 100 days of the year, we have had the biggest and fastest bank runs of all time. We’ve had historic intraday volatility, and yet, certain indices like the Nasdaq are having a very strong run. Amid these conditions, it’s critical to treat your partners as a sounding board.

The hedge fund industry experienced slow growth over the past decade. In some cases, organic performance was muted, but in other instances, firms showcased how they built the dominant $4 trillion industry we see today. Last year, we saw $55 billion in outflows, but those redemptions slowed in the fourth quarter and that’s typically when they accelerate the most. As we look forward, I feel optimistic that this could be the decade when hedge funds truly shine.

Survivors of the last decade are poised to take calculated risks and adeptly navigate volatility that challenges other asset classes. As transitions inherently create winners and losers, this decade will forge new household names. As we look to what comes next, two qualities will be critically important: imagination and efficiency. Funds must embrace both if they hope to successfully maneuver this new environment while capitalizing on fresh opportunities and forming new alliances along the way.

Predictions for the Private Internet Market

Ahead of Jefferies’ Private Internet Conference, we had the opportunity to speak with Gaurav Kittur, Global Co-Head of Internet Investment Banking, and Cameron Lester, Global Co-Head of Technology, Media, and Telecom Investment Banking. They offer insight into the challenging investment landscape of 2022 and expressed optimism for a brighter 2023.

Many internet companies are better positioned today to navigate a still challenging macro environment after spending the last year focused on cost discipline and streamlining operations. However, they face financing terms that have shifted to favor investors, a sharp contrast to what we saw in 2020 and 2021. In 2023, new investments will continue, with investors likely favoring companies that balance top-line growth with profitability. Here are a few other developments Kittur and Lester think investors and companies can expect as they navigate the new normal.

Q: As we approach the halfway point of 2023, how do you view the current market landscape for private tech and internet companies? Is there reason for optimism?

GK: Since mid-2021, we’ve faced an incredibly tough environment, particularly for consumer-focused internet and technology companies. In general, public companies in this sector have traded well below issue price, and VC and growth investing has significantly slowed in the private markets.
Consumer internet companies have seen customer acquisition costs skyrocket. Changes in privacy rules have made it more difficult and expensive to target new groups of consumers, and businesses have also had to reduce their marketing budgets, causing growth to decelerate. The silver lining is that amid a changing macro environment and tighter funding, CEOs are implementing greater discipline into their businesses. Companies have completed RIFs [reductions in force] and are more focused on targeting high-value, profitable customers. Companies demonstrating cost discipline and profitability will have better access to capital. On the investor side, many funds have raised significant amounts of capital but have yet to deploy it. They are ultimately paid to deploy capital, so there is considerable pent-up investor demand to support companies positioned to emerge stronger from the current environment.

Q: Are investors now more willing to sacrifice growth for profitability?

CL: Internet investors will always be drawn to growth. They look for large, rapidly expanding markets experiencing digital disruption, where technology is augmenting or replacing the status quo. Growth is the most dominant element that can drive alpha. With today’s capital scarcity, growth paired with strong positive unit economics and operating leverage will be most attractive to growth and public investors. To that end, companies are extremely focused on spending to attract the right customers.

GK: I agree: growth will always be critical for tech and specifically internet investors. And to Cameron’s point, today’s focus is on targeting higher-value customers and growing LTVs, which will really drive positive unit economics and operating leverage.

Q: Are companies facing similar challenges retaining customers and preventing churn?

Covid had an interesting impact on ecommerce. Consumer-facing businesses initially benefited from the pandemic, as the internet became everyone’s window to the world and primary platform for interacting with society. Clothes, groceries, electronics, and services were all ordered or consumed online. As consumers re-entered the physical world, growth slowed, as many unsubscribed.

Q: As things continue to normalize following Covid-19, which businesses do you feel have the greatest opportunity in the latter half of 2023 and beyond?

CL: Travel is an intriguing space right now. The industry initially suffered enormously during the pandemic, but as new patterns emerged, businesses began to adapt. Capitalizing on the
popularity of working from new locations and outside cities, Airbnb had a huge resurgence, even without the benefit of international travel. Long-term stays are now Airbnb’s fastest-growing business segment, with more than 70 million Americans poised to adopt a ‘digital nomad’ lifestyle.
Another area that shows a lot of promise is the creator economy. TikTok has shown that even markets previously dominated by big tech can be unexpectedly disrupted by newcomers. Even attempts by established players to replicate TikTok’s formula have been largely unsuccessful. We are all creators, whether through short- or long-form, in written or video format. The next generation is defining market trends, as younger consumers increasingly shop on social media platforms.

GK: As investors evaluate what companies have the best opportunities, they should consider whether the product acceleration that occurred during Covid offers tangible long-term benefits. While online grocery shopping felt like a necessity during the pandemic, we have seen many customers return to grocery stores as daily life normalizes. As a result, online grocery or shopping platforms have seen a pull back. By contrast, streaming platforms and remote work, which also accelerated during the pandemic, are clearly here to stay. Additionally, online health platforms are surging due to increased demand for easy access and our society’s growing prioritization of health.

Q: What do you think will define the next phase of development for private internet and technology companies?

CL: I think there is a growing realization that management teams need to focus earlier on building sustainable businesses, not ‘science projects’. We’ve seen this play out among large tech companies where there have been significant headcount cuts in unprofitable business areas. It’s even more vital for young, private companies to prioritize capital investment. In an environment with a much higher cost of capital, they need to make difficult resource allocation choices to succeed. And this is a tough adjustment for some because we now have an entire generation of founders who have never experienced a major downturn or recessionary environment. However, I don’t see this development as a negative. Operating with limited time and resources often drives efficiency and productivity, enabling focused businesses to flourish under these conditions. What sets the end of this recent bull cycle apart from previous ones, and gives cause for optimism, is that many macro trends are more favorable now than ever before. For every failed business that hasn’t adequately addressed its problem space or efficiently deployed capital, three better-managed businesses will rise to take its place.

GK: Absolutely — in a capital constrained environment, the route to success changes. A few years ago, tech product managers would have emphasized building the best product possible.
Now, the emphasis for product strategy lies in making the product usable, feasible, and viable. If they achieve adoption, they can refine it. What’s fantastic is that, after a tough few years, the ecosystem for private internet and tech companies is increasingly stable and the outlook for growth is very positive.

Why Private Equities Will Outperform Public Equities

It’s an uncertain yet exciting time in the markets. Debates continue about the direction of Fed Funds and interest rates, wage and inflation pressures and the likelihood of a soft vs. hard landing. Despite what some perceive as an exceedingly challenging investing environment, there is ample reason to be bullish about the prospects for the private equity asset class. 

My sponsor colleagues and I had the pleasure of attending several sponsor Annual Meetings over the last few weeks and found several reasons for optimism, four of which we detail below:

A Coming Wave of Corporate Carveouts

The public equity markets will continue to offer excellent investment opportunities for private equity including divestitures, take privates and PIPEs – and corporate carveouts in particular.

As companies across sectors have been forced to right size and down size, it’s becoming clearer which ones have divisions that may be underinvested, with strategies that may not align with the parent or management teams that lack the necessary decision making authority. Carving out these divisions into standalone businesses can be a minefield, as it requires intense work and presents M&A and operational complexity. But corporate carveouts done right also present enormous opportunity, and they have represented some of the best performing investments in private equity.

Private equity is particularly well-suited to lead these carveouts because they often have:

• Expertise in negotiating transition services agreements and identifying excess costs.
• Understanding of the complexities of transitioning accounting, financial and IT systems and building a new culture and corporate identity for the carveout business. 
• Executive and operational experience through senior advisors.
• The capital to support add-ons and new capital projects. 
• The ability to create an exceptionally talented board that can create the right incentives for management.

Growth in Leveraged Loans

Tightening fixed charge coverage ratios will increasingly necessitate corporate deleveraging and require junior capital solutions. A majority of direct lending loans, for example, still have maintenance covenants with cushions that are shrinking. That’s why we are witnessing more credits that will require a capital solution and why we expect more opportunities in the second half of the year.   

Many corporates will turn to private equity for structured junior capital, debt buybacks, maturity extensions, up tiering exchanges and self-help junior capital investments. Private equity is well positioned for many of these opportunities given their fund flexibility, new pockets of capital and recycle provisions allowing for up to three years to recycle capital in many cases.

Family-owned Businesses in Transition

Family-owned businesses represent 55-60% of US GDP and are often small and mid-cap companies being managed by 2^nd and 3^rd generations that are focused on succession and wealth preservation. Many are now seeking capital as part of generational transitions and we expect the trend to accelerate given a more uncertain economic outlook and future tax environment. 

Generational opportunities are not listed in any database and require extensive relationship building. They are fraught with challenges but private equity often represents the best source of capital given many of these companies are not exiting via the IPO market given their small and mid cap size. 

This is an area where private equity has an excellent history of great returns and generating far greater wealth for families that roll their equity stake. 

Jefferies has been leveraging our firmwide footprint in many local markets and deep banking domain expertise to identify family-owned businesses and curate introductions within the private equity community. We host ten private company summits each year across many industry verticals and sub verticals and these venues have historically been an excellent forum for family owned businesses to meet several private equity firms and start building a longer term relationship given the importance of finding a “right partner.”

Data and Digital Technology Driving Operational Improvements:

Private equity is often intensely focused on operational improvements at their portfolio companies and has several tools to deploy across an entire portfolio of companies ranging from talent management and recruitment to procurement and other scale advantages. More recently, they have focused on two additional strategies – data analytics and digital technology – to transform businesses. Many private equity firms are finding great success leveraging data to:

Many private equity firms are finding great success leveraging data to:  

• Generate incremental revenue streams. Sponsor portfolio companies have vast amounts of data and are starting to hire internal and external teams to help monetize it. 
• Source and conduct diligence on new investment opportunities.
• Assess their portfolio company’s suppliers, customers, new entrants and leveraging this data to acquire a new standalone platform in an adjacent market.

Although many investors are approaching this investing environment with caution, private equity is adapting with more tools and more creative methods to unlock value and create superior returns for their LPs.  In short, we believe the latest vintage of PE funds will exceed expectations and continue to outperform public equities.

Jeff Greenip is a Managing Director and Global Head of the Financial Sponsors Group. Jeff joined Jefferies in 2008 after holding senior positions at Bear, Stearns & Co. Inc. including Co-Head of Global High Yield Syndicate. Jeff has an MBA from Columbia and a BS from Georgetown University’s School of Foreign Service.