The Capital Playbook 2023

Raising Assets in an Era of Rebalancing

Across the globe, allocators are reassessing and rebalancing their portfolios. Regardless of fund size, the desire to develop relationships and raise assets requires a renewed approach to branding, marketing and investor relations. Hedge funds that can effectively express their value proposition in this new regime are likely to develop new partnerships and strengthen their pre-existing relationships. The Capital Playbook 2023 provides key insights for marketing and investor relations strategy, talent, travel, and customized products.

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What’s Driving the Automotive Aftermarket?

The automotive aftermarket sector has always had a reputation for being resilient during challenging economic circumstances.

This past year was no different. Many aftermarket segments outperformed benchmark indexes and by the end of 2022, the overall sector had doubled the performance of the S&P 500 over the past 15 years. Meanwhile, this long fragmented sector once again spurred a healthy flow of transactions, with 352 M&A deals in 2022 – down from 2021 record highs but still well above 2019 and 2020 levels.

As the inflation and supply shocks of the last few years abates, it’s an opportune time to look at what comes next, which is what Jefferies did when we recently gathered over 100 companies and 200 investors for our 2023 Automotive Aftermarket Private and Public Company Investors Conference. We heard so many reasons to suggest this sector is entering what one of our assembled CEOs called a “golden age.” It’s a sentiment shared by frontline workers turning wrenches all the way up to the C-Suite because of record demand occurring now and strong tailwinds that will blow for years to come. 

It starts with the simple fact that there are more vehicles on the road that need more repairs and servicing. Amid sky high prices for both new and used autos, consumers are increasingly choosing to maintain and repair their existing cars and trucks rather than buy new ones. That explains why the average car on U.S. roads today is 12.2 years old. Meanwhile, there are now 117 million passenger vehicles that are between 4-11 years old, which aftermarket companies consider the “sweet spot” for the most value-added repairs.

But it’s not just the growing demand that is creating opportunity in this segment. It’s also the seismic changes sweeping every corner of the aftermarket, which will create so many openings for smart operators and sophisticated investors to identify and unlock value. Here are just a few trends that are creating the most excitement across the aftermarket sector.

  • Big Data is Even Bigger Than You Think: “In the 1970s and 80s, a car was a car. Today, it’s a smart phone with four tires and a steering wheel.” That was the view of one aftermarket company CEO, while another said, “There used to be dozens of diagnostic codes on a car. Now, there are tens of thousands.” 

    The growing sophistication of vehicles are by necessity turning many repairs from Do-It Yourself to Do-It-For-Me. “Try changing your own wiper blades on a new BMW”, one CEO challenged the audience. 

    Technology is also increasingly changing service models which is shifting everything from how products are stocked, to how consumers make appointments for new tires, to how collision operators need to recalibrate the dozens of sensors on today’s vehicles, while also spurring monthly memberships for unlimited car washes. 
  • Companies Need to Create or Get Access to Scale: There are over 300,000 auto service & retail provider locations in the U.S., with only a handful of players maintaining over 1% of location share, making it one of the most fragmented sectors in the U.S. economy. 

    This can create a powerful advantage for well-capitalized aftermarket businesses – or PE-built platforms – with the resources to acquire businesses and invest in technology, analytics and diagnostic tools they can deploy at scale. 
  • The Power of Customization, Variation, and Enthusiasm: When your car breaks down, you have to fix it. But the aftermarket is about more than routine maintenance. A growing share of the automotive aftermarket is driven by customers’ desire for more customization and variation in the vehicles they drive. Whether its driven by passion or a functional need like a truck bed cover to secure cargo, the market is underpinned by one of the most reliable and loyal customer bases anywhere. One powersports company CEO and enthusiast panel participant noted how new consumers coming into the market over the past three years will drive the aftermarket sales of the future for years to come. 

    If you talk to almost any leader in this industry, you’ll hear agreement that these trends are durable and will continue to unfold alongside the slow but steady adoption of more electric vehicles in the years ahead. The automotive aftermarket sector is poised to grow in new and exciting ways, even as it continues to play its longstanding role as a reliable and defensive play for investors and operators alike.

Jonathan Carey is a Managing Director and Global Joint Head of the Automotive Aftermarket Group at Jefferies.  Jonathan has been in investment banking for 25+ years and joined Jefferies with his aftermarket team in 2015. Jonathan has managed transactions spanning the entire aftermarket channel including suppliers, distributors, multi-unit retailers, technology players and service providers in every industry sub-sector. Jonathan is a regular speaker at industry events and has served as an active committee member in the industry trade association. Jonathan received an MBA from The Wharton School at The University of Pennsylvania and a BA from The George Washington University.

ESG: How the Market Rewards Progress and Quality Data

  • Financial sponsors’ effort to overhaul environmental, social, and governance (ESG) reporting is transforming the industry’s data, and the market is taking notice.
  • Improved reporting frameworks are creating new opportunities to capitalize on ESG assessments, for top-rated companies and historic underperformers alike.

Intangible ESG

2022 was a challenging year for the ESG community. As the influence of ESG ratings grew, so did public scrutiny, with many criticizing the industry’s data as inconsistent and ill-defined.

Across the political spectrum, there is growing consensus around the need to focus on financial materiality in investment decision-making, but some skepticism that ESG assessments are substantive enough to be a core focus.

Some of this criticism was well founded. ESG ratings – like many financial assessments – were frustratingly subjective. Different methodologies engendered variable results. As recently as 2021, despite the sector’s growing influence, no standardized framework for measuring and reporting ESG data existed.

New Reporting Frameworks

Leading LPs and GPs in the financial sponsors space have confronted this challenge head-on. In 2021, CalPERS and Carlyle led an effort to create a mechanism for comparative reporting, benefiting stakeholders across markets. This project, known as the ESG Data Convergence Initiative (EDCI), is uniting private companies around a meaningful, standardized set of ESG metrics.

Participating companies report data across six categories, using a globally accepted and objective submission template. The EDCI ensures this data’s viability for a large network of financial sponsors and investment managers. Today, more than 275 leading financial sponsors, representing more than $25T in global assets, are committed to the EDCI.

Financial Sponsors like Carlyle and CalPERS are pushing their portfolio companies to obtain and report this data, but they are far from alone. In the private equity (PE) community, over 80 of the top-100 PE firms have a partner dedicated to ESG on their investment committee. Whether firms are selling sponsor to sponsor, working with family offices, or taking a business public, ESG plays an important role in enhancing the value of portfolio companies.

Similar efforts are underway in public markets. The EU recently introduced mandatory disclosure requirements for all large and listed companies on their risks and opportunities arising from social and environmental issues, and on the impacts of their activities on people and the environment.

While the SEC does not yet require extensive ESG disclosure, it is expected to follow the EU’s lead and already mandates climate disclosures encompassing emissions from upstream and downstream activities.

A ‘Transition’ Mindset Emerges

For years, ESG evaluations lacked nuance. With fragile data, companies were viewed as ‘green or brown’: strong on ESG or weak on ESG, there was no middle ground. As the quality of ESG reporting improves, so has the quality of ESG analysis. Today, financial sponsors and investment managers have adopted a mindset that values ‘transition.’ Companies are not judged on their history, but on their commitment to progress.

The market is patient, but it wants to see data, analytics, and intentionality. Even historic underperformers can represent great investment opportunities, if they can showcase their efforts to track meaningful metrics and make improvements. Markets are rewarding companies that advance ESG strategies, something priced in and reflected in their multiples.

In the coming years, companies should develop inclusive, analytical frameworks for understanding sustainability, human capital, and corporate culture. Those that fail to demonstrate a commitment to ESG risk significant consequences from their investors, their employees, and the SEC.

Ignoring ESG Invites Risks

The EDCI’s database of meaningful, performance-based assessments is gaining traction amongst LPs and GPs. As these metrics continue to gain wide spread adoption, companies who do not engage with this process may struggle to raise capital and attract top talent.

Jefferies delivers customized ESG guidance to clients, offering unique access to public and private sector ESG thought leaders for investors and corporate boards. The firm’s specialized expertise, followed by actionable and timely strategic insights, can ensure your company capitalizes on the market’s swiftly evolving assessment of ESG.

How HCM Tech Companies Are Shaping the Battle for Talent

Talent is the most important strategic asset for any company and even amid layoffs and a cooling labor market, many C-Suite leaders are still consumed with a vexing question:

Where do I find talent and how do I keep it?

The answers are not getting easier, especially as businesses are faced with shrinking recruiting budgets and forced to do more with less.

But this challenge represents a compelling opportunity for the 35 companies and 45 investors that recently assembled at Jefferies’ HCM Tech Summit in New York.

As I listened to the panels and joined in some of the hundreds of 1×1 meetings we hosted, it became clear that the most value creation, the most growth and most accretive transactions in HCM tech are likely to occur at the intersection of a few key trends fueling the sector in 2023 and beyond.

  • Upskilling and Reskilling: In the U.S., there are still almost ten million job openings, 1.7 for every unemployed worker. The skills shortage is even more acute among frontline worker positions, where there are three openings for every non-college person in the U.S.

This means upskilling and reskilling will be the preferred route for many companies to address their talent shortages in the months and perhaps years ahead. Some of Jefferies’ HCM clients enable their customers to identify and address skill gaps in real time across their entire global workforce. Others provide content, training modules or learning tools that close these gaps, bringing enterprise-grade technology and content to companies that otherwise lack the budget, bandwidth or know-how to develop on their own. We are increasingly seeing immersive and engaging training experiences rooted in the deep science of how people learn. It’s often easier to remember what you experience than to remember what you read or hear, which is why virtual, augmented and extended reality – often enhanced by AI – is quickly becoming such an integral component of the on-the-job learner’s experience.

  • Retention: We’ve all read about the post-COVID “Great Resignation” and the costs are adding up: It can cost anywhere from 50-200% of an employee’s salary to replace them. That’s why we are seeing such a proliferation of software companies with tools that can help promote employees’ health and wellness; measure, achieve, and sustain workplace equity; solicit, process and respond to employee feedback; and accommodate more flexible work arrangements.
  • Generative AI: At many companies, HR teams are overwhelmed by an escalating number of responsibilities and business challenges. At our HCM Tech Summit, one of Jefferies’ HR professionals lamented it felt like a full-time job just responding to the “pray and spray” marketing appeals from different HCM software vendors. Generative AI tools have the potential to streamline and automate talent workflows, especially when it comes to:
  • Identifying potential biases in job descriptions or applicant screening processes or analyzing large datasets to make the hiring process more inclusive.
  • Offering guidance on HR policies and assisting with routine inquiries.
  • Generating compliant and effective job requisitions, postings and candidate engagement.

We are still in the early innings of the AI revolution in HCM software, but we already see many compelling use case and product prototypes emerging across our client base. Much more to come here, and soon!

  • Global Employment: As the war for talent intensifies and multinationals face a global talent shortage of over 85 million workers by 2030, companies are increasingly looking to find skills beyond the borders of their original domicile. A new generation of global employer of record (EoR) businesses enable their clients to compliantly hire and retain workers virtually anywhere in the world. But that’s just the beginning. Soon, EORs will more beyond HCM and transform into comprehensive systems of record and transaction enablers for their global customers.

Given companies’ urgent needs to find and retain talent, it is not surprising that most HCM leaders Jefferies’ has spoken with expect to increase their spending on innovation and to buy where it is prohibitively expensive, or time consuming, to build.

In a rapidly changing world, time to market is critical, and every vendor, whether an incumbent or a high-growth startup, will also look to augment their go-to-market and product through acquisitions. As a result, we expect continued consolidation and capital raising activity in our space. Finding and keeping good people has rarely been this challenging or more important. That means the opportunity set for innovative HCM tech companies has never been this promising.

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.

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.

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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.