The availability of abundant private capital and credit is fueling strong M&A activity, along with the ability for business owners to raise funds for growth. But the equity market offers challenging times ahead. These are some of the perspectives from three capital markets experts who addressed an audience of business prossionals at "The Current State of Capital Markets" breakfast forum hosted by BoyarMiller, a Houston-based business and litigation law firm.

"The viewpoints shared with our guests in attendance provided a greater understanding of what is happening in the capital markets, which is so important to every business and industry in Houston," said Chris Hanslik, BoyarMiller chairman. "The forum is one of the ways we bring relevant information to our clients and business partners to support their planning. Our speakers delivered powerful perspectives about market activity that may influence their decision making."

The panelists included: Kamden Kanaly, Chairman of KDK Private Wealth Management; John Sarvadi, Executive Managing Director, Corporate Banking, Texas Capital Bank; and Scott Winship, Managing Director, Gulfstar Group Investment Bankers.

Stay Diversified

Kanaly told the audience that equity markets look challenging for the foreseeable future. "We think it's time to be cautious as equity markets look fairly valued to us at this point. It's been a great run over the last few years but going forward a lot has to go right to continue justifying these valuations."

He advised the audience to keep their investment portfolios diversified, and to make sure they understand the levels of risk inherent in their allocations.

"We've come out of an environment with very low levels of volatility, so it's fair to say there is some complacency built into the market. It looks to us like we are in the second or third inning of a range-bound environment for equities, so we think it is a time to be prudent and likely under-invested in here as things get sorted out. If you bought the S&P 500 a year ago you've traded in a 20 percent plus range and net-net you've only earned your dividend. We are already in an earnings recession as this will be the third consecutive year-over-year quarterly decline in earnings, and for the first time in a while, top-line sales are also declining, which no one is really talking about," said Kanaly.

Kanaly mentioned that the collapse in bond yields and the recent inversion of the yield curve was not a good signal to investors. Several of the last recessions were led by the inversion of the yield curve and typically they occurred six to 12 months after inversion, according to Kanaly.

"That means in mid Q1 or early Q2 of 2020, we should know whether we are headed towards an economic recession," he said. "I don't see a deep or prolonged recession coming because we benefit from lower interest rates, the availability of credit, and low unemployment, however it does appear we are in for a slower growth environment as this economic cycle runs its course. With that in mind, we are trying to take advantage of the volatility, as well as allocate to other alternative asset classes and opportunities that historically have done well in either an expansionary or recessionary environment. We don't want our clients' outcomes dictated by what does or doesn't happen in any one asset class or market."

Frothy Debt Capital Market

Middle market companies – those below $50 million EBITDA – are experiencing a current debt capital market characterized as "frothy but not yet overheated" by Sarvadi of Texas Capital Bank.

"It is a matter of supply and demand, and there is a tremendous amount of capital that is still available to be deployed," he said. "Banks are well capitalized and they have had decent earnings. It has been a fairly benign credit environment for the last several years, so banks are healthy and have capital available to lend. This is a good time to reach out to your banker."

Sarvadi offered three points of advice to business owners seeking funds.

"First, raise capital when you can get it at attractive terms, not just when you need it," he said. "Become a student of the debt markets and be open to calls from lenders who want to inform you about current market activity."

He also advised to be conservative and have a capitalization plan that can withstand some downside, whether from a revenue perspective or margin compression.

Lastly, Sarvadi said to surround yourself with knowledgeable professionals.

"Don't skimp on advice and counsel. Have a team of attorneys, accountants, bankers and others that will provide sound counsel. I see many times when an emerging business doesn't want the expense of getting professional help. But being on top of your numbers and your business is an important factor."

Overall, he said it is an excellent time to raise capital. "We're seeing loosening of credit protection in the market, fairly loose covenants, and aggressive EBITDA adjustments and repayment terms."

Robust M&A Activity

A decade-long upswing in merger and acquisition deals continues this year, according to Gulfstar Group's Winship, led by the debt market.

"Overall debt availability, as well as low interest rates and accommodative terms, are very supportive of transaction activity," he said. "In the private equity market, there is close to $800 billion of uninvested capital on the sidelines waiting to go to work and produce a return. Given that PE funds have durational limits, this capital has to get to work with some expediency, otherwise, there is an impact on future fundraising aspirations."

The need to get private equity capital working has resulted in more aggressive valuations being paid and moderate return expectations accepted.

"There is a lot of transaction activity in deals where there may be strategic merit between two companies, but a private equity firm is able to convince the seller that the value creation may be greater in a few years after their guidance and strategic influence," said Winship. "We are going to continue to see private equity buyers win deals that used to go to strategic buyers."

He believes that discipline in the traditional bank market is very high, which is a positive factor. He questions whether the private debt markets have the same discipline because it is a more aggressive environment.

"We are optimistic about the visible horizon," said Winship. "We are feeling good about where the market is right now. But when you see the debt market tighten, that's when you'll see our markets start to tighten up as well. That is the key signal that the deal community focuses on, and we're keeping a close eye on the financing markets given that we are in a long tail in the current cycle."