The Anatomy of a Great Deal

Assalamu aalaykum. Hello everybody and welcome to day two of Abu Dhabi Finance Week. It's a great pleasure and honor to be back here in this beautiful capital of the United Arab Emirates. And welcome to you gentlemen flying in from New York, Paris, and London. First of all, to kick off this panel, I want to ask you, you all have long careers in deal making, but is there one single deal that stands out and made your career?

Let me start with you, Donald.

Uh, well, I don't know if it made my career, but um, a transaction that stands out, it's probably something more recent. Um, it was a deal we did in 2017. Um and it was a deal that um was quite complex. Uh it was the acquisition of Novo Bankco and Portugal. Um this is the bank that was the result of Bankos Santos um being taken over by the Portuguese uh state.

Um I think there was a lot of concern by um others in terms of the complexity of execution, how to value the assets on the balance sheet, how to deal with the stakeholders. Um you have the central bank of Portugal, the ECB, um you know, as well as uh the European Commission. Um we invested a billion euros in the bank. um it had uh 90% uh cost income ratio at the time. Um we ended up having to reduce the MPL ratio from by 90%.

Um and we successfully turned the bank into profitability um and uh executed a sale agreement with a French bank uh BBCE uh earlier this year. Um so we acquired it for a billion euros. uh we sold it for €6.4 billion euros. Um but I think the other thing that kind of makes us quite happy is that you know the sale process was one where uh we really took into consideration all the factors um uh that were of importance to the workers, the employees, the management in the state.

So I think it was a good result for Portugal and certainly a good result for our investors.

Bob, what was the number one deal of your career so far? I think number one is clearly the acquisition of the US um Lehman Brothers business during the financial crisis in 2008. Um it was truly a bulge bracket bank. Um truly a world leader in equities and mergers and acquisitions and mortgages. Um, it was a business that we actually tried to buy the entire thing over that weekend and the weekend was probably tougher on the whole world as it turned out and nothing happened and they declared bankruptcy that night.

But we had the uh the fortitude and the support of our board which at that time was really really important is the world was kind of falling apart on that Monday after Lehman weekend and we're able to acquire the US business out of bankruptcy um by the end of that week. Excuse me. I won't repeat the whole thing, but it was the the opportunity to acquire the Lehman Brothers bulge bracket US business over that weekend. In the following year, 2009, a business which we paid one and a half billion for the building was worth2 billion.

We made $9 billion in the first year. So, it was in and I would say the other thing to be perfectly frank, the reward was also the saving of 10,000 jobs. Yeah, absolutely. The human component is so important and you mentioned the culture there as well. Over to you Thomas.

What was the most exciting deal of your lifetime so far?

So, thank you. So, it's it's actually a series of deal. My point here is that in long-term investing, at least on the equity side, in order to do the best deals, you need to make sure that you are part of a, you know, secular trend and that you catch this trend pretty early in the cycle. So, I'm talking here about energy transition. We started investing investing 10 years ago in that uh in that field.

It was not very well known. We launched the first ever private equity fund dedicated to energy transition on the back of two very strong convictions. One was that with regards to the solution providers to the energy transition um financial return and impact were actually two side of the same coin. Um and the second conviction was that the world was actually switching from uh a place where value creation was driven by efficiency on the back of 40 years of downtrend in interest rates and globalization that has allowed allowed companies to overoptimize a lot of things from capital structure to uh supply chain. Um to a world where growth would be driven by value creation would be driven by resilience.

Um and uh and and in that context probably that growth would have to slow down because we will be living in a world which was which would be less optimized and in that world of low growth the pockets of high growth would be concentrated on uh the solution providers to the resilience. And so we read the IPCC report figured out that in order to achieve the energy transition and the Paris agreement the target sets at the par at the Paris in Paris at COP 21 uh we collectively needed to deploy $6 trillion of capital every year in energy transition of which 80% had to be concentrated on transforming the existing system. So meaning that you can invest you could invest in you know venture capital technology that would you know maybe save us in 15 years for 20% of the of the you know investments but 80% had to be driven by transforming basically industry agriculture transportation and buildings and so we started investing in those companies low tech companies boring businesses that in the end you know caught up this uh very long-term secular trend. um those companies started to develop in Europe because you know the um actually regulation was tougher there and now they are developing everywhere in the world um and uh it's probably the best uh you know the best investment we've made um so far

congratulations Mabuk to all of you and we can learn a lot from all your experiences I think you should all be professors of finance at some point or write the book at least Bob you have uh closed some of the biggest financial transactions uh in the world. Um what is a measurement of success? What are the key factors how you basically after a deal closes you are like well this is a a good deal? What makes you think that?

You know I touched on it a little bit. There's there's always um a nice feeling as I said when the result of a good transaction was saving 10,000 jobs. And I remember as we were negotiating for that, Mayor Bloomberg of of New York City at the time came to the office, kind of grabbed me by the lapels and said, "Bob, you do realize the impact of this on New York City." None of that takes away from the fact that all of us are in the business where you know we need to have the right valuation

and we need to have the right alignment with management

and ultimately the right rewards for the investors and for the shareholders. But I think, you know, to your question, it's a great feeling when we're able to do all of those things and create something strategic

um something that's going to be ongoing uh and something that can create economic value in in job creation. But from the very very beginning I have found that if I focus or if we as a team focus on the valuation when we enter uh in investment and the alignment of management with the investors we generally come out with a pretty good outcome. Now in this anatomy of deal making how is AI and that is a question to all of you and new technologies and machine learning how is it disrupting or supporting traditional deal making

Donald?

Okay. Um well look I mean we certainly analyzing how um AI can be helpful to our businesses. I mean the the space that we're in um is much more industrials, manufacturing. So old world economy um so not directly related by AI but certainly a space that um is going to benefit from the utilizing these tools. And I think one of the things we look at is um the disruptive force that AI could have uh to the model of of the company um whether it's calling centers or um some sort of service business.

But what's more relevant is um you know we've worked to set up a center of of excellence in AI uh within our underwriting team uh to look at opportunities of value creation. You know how can we improve supply chains procurement pricing you know we have companies that have three or 400,000 SKU items um in inventory that need to be matched with buyers and so we have RFPs coming in. how can we utilize AI tools uh to try to um optimize meeting that customer demand. And so I think one of the things we do is we look at you know um that as a very specific uh uh space within our due diligence process the opportunities that we have and certainly analyzing the risks uh that it can present but I I you know it's it's a necessary part of every uh transaction that we look at.

Do you agree with that Thomas?

Yes. So there there are several angles to to the question. First I mean in terms of investment company we are using AI mostly for to improve uh you know client servicing reporting uh to screen deals. So the first layer of deal screening is you know benefits a lot from the the you know the inputs of of AI also for what we call connect the dots. So who knows whom in you know boards and networks etc.

We we're using AI for that. But something which is very important for me is to keep AI away from making any kind of investment decision. So I think that's I mean at least it's a very strong conviction that investment decision needs to uh to remain a human decision also not only because uh of the you know uh of the potential danger it represents but also because we we like to be contrarian and I think that you know you cannot necessarily be contra contrarian if you you are using too much of of AI to take your your decisions. So then of course assessing AI impact on our portfolio companies and how AI can AI can help or threaten your portfolio companies is paramount. And then there is the last but not least I would say the opportunity in itself to invest in AI and there as we are a bit contrarian uh we we are a bit reluctant about you know putting money where everybody goes um currently.

So the play we we've taken to navigate this AI ecosystem is to finance data centers. So we we think that you know instead of being an owner there is a sweet spot for data centers that are that have secured their power secured their building permit but not found their final client. So you take construction risk and commercialization risk and that you can finance at double digit returns which which are you know kind of equity like returns. Um so we like to do that and also as we as I told you we like to f we like to finance the sellers of picks and shovels. Um and so the play on energy transition is also a play on AI because again reading the IPCC report in order to achieve energy transition you need to electrify the end user.

To electrify the end user, you need an efficiency of the grid. And the companies that are helping this efficiency of the grid being companies involved with the maintenance of power cables or developing software to optimize solar farms are also a play on AI.

Yeah. When it comes to Yes, Bob. Go ahead. You

know, one of the areas that we're working on at Atlas Merchant Capital is the consolidation of regional and community banks in the US.

And most people, even Americans, don't realize this, but there are 4 and a half thousand banks in the United States. And ever since the steep rate increase and the failure of SVB, we're seeing regional and community banks combining. So using AI as an example, there's really two ways it's helpful. One is the enormous amount of work that our staff does in looking at the four and a half thousand banks and where the opportunities are to be an acquirer or to be acquired. AI has been an incredible help in speeding that process up um much more quickly with much less stress on our team.

And then secondly and amazingly as we have identified the potential winners and complete transactions in merging is the value of AI to these smaller institutions and their ability to compete with JP Morgan and BFA is phenomenal. So it's really on the front end of helping us you know work through the universe of opportunities and narrow them down and analyze them. But also in banking the impact of AI in the efficiency of the smaller um as they compete with the larger um is really incredible.

Yeah. When it comes uh to downside planning uh Don how does your team approach that and uh what kind of advice do you offer?

Okay. Um well look I mean I think any of these transactions we're sector agnostic. We're non-theatic. So, we're looking at each individual transaction as a standalone. Uh, we're doing our best to dive into those situations.

Um, you know, the norm is not to have perfect information. Um, so we're always, uh, doing what we can to analyze on a line by line basis. I mean, an extension of the previous conversation, um, one of the uses for AI, you know, AI is a tool. Um, it's not an end, it's the means. uh we use AI to help try to um um access and crunch a significant amount of data as best as possible.

But you know the single biggest thing we want in those situations where we have less than perfect information uh is to uh make sure um that which you don't know doesn't kill you, right? So we try to assess the gap um and uh within that we try to structure as best we can around it. Um and at the end of the day, if you feel like um you know there's a key element of of information uh missing to help you to determine the ongoing viability or um uh the business prospects for this company um you know we walk away.

Yeah. Yeah. Um at TKO Thomas you really emphasize uh patient capital and differentiated uh sourcing as well when like the whole market goes against the flow but you're still convinced on a successful transaction and that this deal is actually going to be successful what makes you keep going on that track like why are you convinced and and can't you know um stay away from it? Well, I I think you you need to in in this new environment, you need to have very strong convictions. I mean, the easy days, I would say, of uh of private asset investings investing are over.

I'm sorry to sorry to tell. Um there will be much more dispersion than than before. um you know if I shatize and of course I'm I'm I'm exaggerating but buying an asset like business putting a lot of leverage in front of this asset like business and waiting for interest rates to go down to refinance your debt and benefit from multiple expansion is is not something that will will create a lot of value in the in the coming decades. So you need to have strong convictions. Um I think the way to invest in private equity will change a little bit.

Um if you look at you know companies in the world they will be less optimized. uh the fact that you know that they need to be more resilient. They need to produce closer to uh to the consumer. It's more costly. The cost of insurance is increasing.

Cyber insurance, climate insurance, corporate insurance. U you know they they need to operate with higher capital buffers, less debt uh to cope with crisis like the COVID crisis. They need to operate with more inventories. So I think you know efficiency is less of a of of a paramount for that. companies need to, you know, slow their their growth.

Earnings growth is going to slow. Um they need to be um they need to be more resilient and they need to be more asset heavy. Even in tech, look at you know Microsoft, they are more asset heavy than than before. And so I would say that my point is Warren Buffett investing is probably the you know the new way of investing in private equity. And so I think we're going to look more at the way the cash flow is allocated, the way the asset allocation is made because you know building the right plant at the right place at the right time is is not is not easy.

It will create a lot of dispersion. looking at you know return on invested or on capital employed on invested capital will be more important than before and you if you look at what we've been doing at TQO for the last 15 20 years we've invested in sectors where you know companies are more asset heavy we have used less leverage than the average of the industry three times a bit on average for our current portfolio um and and we are pretty comfortable with that way of investing going forward

Bob if you have to give just a little master class uh on how to structure a deal because the interest rates they keep moving the uh regulatory environment keeps changing but what are like the key ingredients how do you structure a deal the basics

well I think right now in financial services um specifically do you hear that okay I think yeah in financial services specifically we've seen a change of administration in the US that is much more positive on consolidation, much more encouraging of the consolidation of regional and community banks, much more proactive in innovation allowing the IPO of Circle for example and stable coins and in uh digital versions of the dollar. So we have some real tailwinds right now and I think that's [clears throat] that's very important. I think what is counterintuitive to people is that generally higher interest rates are beneficial to financial services and the lower the interest rates go and the flatter the yield curve the more challenging it is. And so over the last couple of years since the rates have gone back up having rates at this level where the expectation is a decline in a positive yield curve is the best environment in the world. So when we look at investing in financial services right now, there's a clear tailwind from the US administration in terms of being proactive in an integrated, simple, straightforward regulation.

And I think that's spilling over into the other place we like to invest, the UK and Europe, where they're becoming more competitive in financial services.

Yeah. uh Donald uh when you know a deal looks super attractive like the terms and and and the sheet and like the whole macro environment is super um perfect. What still makes you move away? Is it like the gut feeling still intuition or something or a personal connection? What could make you

so why not why why not to do a deal? Um, look, I think there's there's always a lot of reasons uh that you can find uh as an excuse not to move forward. I mean, I think for me, um, one is probably more because of the investment style we have, which is, as I mentioned, um, you know, we're we're non-thematic. We're we're investing in um, situations where we're trying to affect a step change in the company in the first two years. um that really means assessing the optionality, the levers that we can pull in the transaction to create value.

And I think at the end of the day, if the situation is one where you know our return is really going to be driven by simply, you know, multiple expansion or topline revenue growth, um where there isn't a lot of alpha to add, it's probably not a deal that is interesting for us. Um but I think if there's one singular thing for me um that's a deal killer is is um is what I call a a transaction that has low probability high severity risk. Um so quite simply the risk of an event may be have low probability but it's existential. Um and it can be a situation where you have a company with a predominantly one major uh customer u and maybe its switching costs are not that high. um where contract terms allow it to terminate a significant part of the of the of the economic agreement in place or it could be one where there's a significant regulatory overhang or the risk that you know a change in policy or change in regulations um turn the business model upside down.

So and I think those situations exist um but it's you know assessing that and taking a decision affirmatively that you know it's not a risk that you're willing to take. Um, that's something that's a that's an obvious deal killer for us

and and it can be hard because the deal can look really attractive on a relative value basis with a good management team, but at the end of the day, we want to take any risk to the capital.

Before we go, I have a final question to all of you. I need to finish on time because I'm Swiss. So um I want to ask you what does the deal of the future look like in terms of structure but also geographies and maybe industry as well. Thomas any bet?

So I think you know with declobalization and uh the building of resilience and sovereignty everywhere you need to be local.

Yeah.

So as a principle we do not invest in countries where we don't have an office. Um at the opposite it's very rare that we do only fundraising in one part part of the world because we think that fundraising goes with local investing and and both are you know u serving each each other. Um and so you you you need to be uh you need to be very local. You need to have very uh strong convictions. And of course um the uh Middle East and Asia-Pacific uh region is of course uh extremely exciting when you look at the the stats there are many of them but you know just one is when you when when you take Hong Kong you draw a cycle of five hours flight around Hong Kong.

uh it you know that's an economist called Charles Gav saying that in this cycle you've got more people than outside so on earth you've got 69 of the of the top 100 cities in the world inside this cycle and when you look at the way those cities have developed they've developed very independently one from another because there was no infrastructure for example there is no direct flight between Delhi New Delhi and Beijing right the two most populous countries in the world So the fact that you know there is a lot of infrastructure spending going on in this region from highspeed train to airports to uh you know power lines uh ports etc roads will probably create a lot of value in this region and of course listening to what sovereign wealth funds from from GCC are saying they are massively pivoting amounts of capital large amounts of capital towards this region. So Asia is very exciting. Bob, [clears throat]

there are two things going there. We're we are we think of ourselves as experts focused on financial services. We spend all of our time on financial services. And there are two phenomenal things going on right now. One is of the four and a half thousand banks in the strongest economy in the world with the best financial services industry in the world in the US.

There is a need for consolidation and it is just throwing out values. The smaller banks who provide so much 50% of the lending to small businesses comes from the regional and community banks and yet the smallest are safe but just too small to succeed with the cost of technology and the cost of regulation. Consolidation will make the whole sector stronger, better competitors to the big banks and better servicing of small and medium enterprise businesses. And it's all about cost synergies. It's too good to be true.

The second thing we see and we really learned this when we began investing in circle the US digital coin USDC in 2021 in 2022 what's happening in the blockchain is really profound and we believe that the benefits of that technology over the next three or four or five years we're going to see blockchain emerge as the underlying technology of financial services at large Not just in the US, but frankly here in the Middle East, more of the banks in Abu Dhabi, in Dubai, in Iraq, in Qatar, in in the kingdom are already using blockchain in some of their businesses.

Yeah. What a different landscape than when you came here 30 years ago, right? For the first [laughter] time.

Very different.

Bob has been here uh many decades ago for the first time. What about you? Final words, Donald.

Sure. Um and look the risk of answering this question last is that some of it's already been repeated but um you know look I think we are the global aspect of our um economies um and the business flows were inextricably linked with each other and I think that's going to continue um I think the financial literacy continues to to rise uh globally um which gives rise to transactions u in areas where maybe historically we wouldn't have invested and I think for US rule of law is incredibly important. Stable financial uh systems are important. Uh but when you look at for example places like here in uh the UAE and Abu Dhabi in particular, you have a high level of of financial professionalism and an interest in working together in partnerships. And I think you know capital as partners as opposed to um just an investor is something that is continues to ramp up significantly.

um you can see that in the quality of the of the people attending here today and the interest in in a format like this and and I think um you know for us we have you know looked at the region in a in a very different light over the last several years in terms of the operating businesses we've moved into the region um and what we're trying to accomplish in partnership with with existing family businesses here and families who are interested in expanding beyond the borders of of the region outside of the GCC. And I think that's that's very exciting. Um and and you know and I think it's good um for uh for us to continue uh focusing on the dialogue that helps that to happen.

Do you think that the next big deal will come from this region?

Well, I certainly think Yeah, I'm hoping that the next time you ask me the most profitable deal we've done, I say it comes from the region. So

in exactly one year time uh here at Abu Dhabi Finance Week, we will know more. Thank you so much Donald, Bob, and Thomas for your insights. Shukang Gasilan. Thank you.