Power Players

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The deal finalizing Tencent’s acquisition of the remaining piece of Riot Games Inc. it didn’t already own was announced without fanfare on Dec. 15, 2015.

Buried in a three-paragraph posting on the West L.A. video-game company’s website was a terse bulletin: “Our majority investor, Tencent, recently purchased the remaining equity of Riot Games.”

Missing from the post – which included details on employee compensation structure and assurances of continued snack availability – was the news that company co-founders, USC graduates Marc Merrill and Brandon Beck, had just been rewarded with what sources say was an overall valuation that broke the billion-dollar barrier.

In many ways, Riot’s acquisition by the Shenzhen, China-based Tencent was the quintessential L.A. case study: Young entrepreneurs build a company, take some outside investment to grow it, explore the possibility of a public offering, and ultimately get acquired by foreign money to precious little fanfare..

It’s a story that speaks to both the region’s deeply entrepreneurial spirit and the reality that Los Angeles has never really been – and might never be – a Fortune 500 town.

High tax rates, consumer-friendly courts, and a pro-labor state Legislature have left the region with only a handful of the world’s biggest companies: just 13 L.A.-based businesses were listed on Fortune’s list of 500 largest public companies in 2015.

Yet despite this lack of headliners, the L.A. economy is thriving – it ranks as the 20th largest in the world, according to the Los Angeles County Economic Development Corp. While New York, Chicago, Houston, and San Francisco (thanks to the tech boom) have established themselves as homes for corporate behemoths, Los Angeles is characterized by its diverse middle market, which can represent deals as small as $20 million and as big as $2 billion, depending on whom you talk with.

A host of industries – from entertainment to consumer products, technology to aerospace – underpin the area’s vibrant business ecosystem. Recent noteworthy deals include Samsung Electronics Co. Ltd.’s August acquisition of luxury kitchen appliance maker Dacor Inc. of City of Industry and the sale of Mid-Wilshire research company MarketCast to private equity firm Kohlberg & Co. in October.

“If you were to draw a circle around 100 miles of where we’re sitting today, other than the fact that about 30 percent of it would be in the ocean, the other 70 percent would be the most fertile place in the world for the number of midsized and smaller companies,” said Jim Freedman, chairman and managing director of West L.A.’s Intrepid Investment Bankers. “It’s just amazing how many companies are in this geographic region and continue to spawn (here).”

This arrangement makes Los Angeles a dealmakers’ paradise and supports a strong base of investment bankers, private equity firms, commercial banks, and attorneys in the mergers and acquisitions space.

In fact, the middle market is so strong here that some heavy hitters, including Bank of America Corp., are expanding their footprint to tap into the deal pipeline and diversify operations. While BofA ranked fourth overall globally in M&A activity in 2015, according to Thomson Reuters, it was 23rd in deals worth less than $500 million. That’s changing, said Raul Anaya, president of BofA’s L.A. office. Over the last few years, the bank has increased its number of commercial bankers here by more than 20 percent.

“The last three or four years in the middle market in L.A. we’ve been growing in double digits,” said Anaya, who guided Rochelle Sterling through the $2 billion sale of the Los Angeles Clippers to former Microsoft Chief Executive Steve Ballmer. “We expect that trend to continue both because of the growth opportunity we see and the size of our book.”

International influx

Anaya isn’t alone in being bullish on L.A.’s middle-market deal economy. Larry Braun, a partner in the downtown office of Sheppard Mullin Richter & Hampton, describes the region as the primary entrance point for international companies looking for acquisition targets.

“We’re starting to see a lot more happening in Los Angeles, and I think it will be a gateway for investment into the United States,” Braun said. “You’re already seeing it happen. People are buying into L.A., and into the rest of the U.S. through the L.A. marketplace.”

The best access point – both from a value perspective and to avoid heightened regulatory scrutiny – is often the middle market. In 2016, this trend of middle-market international investment into Los Angeles was highlighted by numerous deals.

Dalian Wanda Group’s $3.5 billion all-cash deal in January for Burbank’s Legendary Entertainment was one of the early headliners. The purchase of the production company behind “The Dark Knight” and “Jurassic World” cemented Chinese billionaire Wang Jianlin, Dalian Wanda’s founder and chairman, as a Hollywood player, and showed how strong the market is for entertainment companies despite the industry’s struggles with a changing media consumption landscape in the United States.

Alison Ressler, a partner in Sullivan & Cromwell’s Century City office who helped lead the Legendary transaction, said she thought the deal held good value for Dalian Wanda, partly because entertainment companies are safe targets for Chinese companies looking for a U.S. entry point.

“There’s been a lot of activity,” she said. “The entertainment industry has been a little less controversial than other industries. There’s also been a lot in the technology area, which have raised questions about whether you need (stricter regulatory) approval.”

It’s not just the Chinese who’ve come shopping in Los Angeles. London’s Unilever purchased Venice’s Dollar Shave Club for $1 billion in July. The acquisition of the men’s bathroom products e-tailer established a new benchmark for early stage consumer product companies, and L.A. dealmakers almost universally praised Unilever’s decision to pull the trigger despite the hefty price tag.

“The Dollar Shave Club deal was dramatic,” Sheppard Mullin’s Braun said. “You’re seeing all these companies growing in the consumer products area through social media. There are a lot of companies out there doing unbelievably well with great margins growing dramatically with no storefronts at all.”

IP-no?

Dollar Shave Club’s successful exit was tempered somewhat by the travails of another rumored Unilever target: Honest Co. The Santa Monica e-tailer of eco-friendly home and baby products, whose co-founders include Jessica Alba and Brian Lee, was seen as a unicorn (a privately held growth company sporting a valuation of more than $1 billion) that was ripe for an IPO or acquisition as early as 2014. But timing is everything, and amid 2015 news reports that certain Honest product claims were misleading or false, interest from potential suitors appeared to wane and talk of an initial public offering dissipated.

Honest’s reluctance to enter the IPO market could also be a product of seeing the ups and downs of other L.A. unicorns that went public, companies such as ad tech firm the Rubicon Project Inc. and online automobile seller TrueCar Inc. Given the demands that come with being public, many dealmakers said there’s been a shift toward acquisitions as the preferred exit strategy for small and midsize businesses.

“You really need to be at size to be public and you need to be at a point where you’re mature enough where you can hit your numbers, whatever those numbers might be,” said Lloyd Greif, president and chief executive of downtown investment bank Greif & Co. “Being a public company is all about strong growth and consistent growth. If you’re not at the stage where your technology can sustain (growth) as a public company, I think a private placement makes more sense.”

This shift is partly cyclical, according to L.A. dealmakers, but it’s also a product of increased competition between private equity players and strategic buyers over premium targets.

“There is so much capital that if you’re a good company, a really good company today, you’re going to get really high valuations from a lot of folks,” Freedman said. “There’s a lot of pressure to do deals. These private equity funds raise money from institutions, pension funds, universities, endowments, insurance companies, and they have to put that money to work, so they’re really aggressive.”

With the IPO of Snap Inc., the newly renamed Snapchat, expected to come at the end of the first quarter of 2017, some analysts are optimistic about a resurgence in public offerings, though most want to see proof in the market before heralding their triumphant return

“There’s some expectation that (the IPO market) will improve next year, particularly for tech companies,” Greif said. “Although I’m not necessarily a believer of that yet. I’m from Missouri: Show me.”

Uncertainty certain

Looking ahead, most of the L.A. power players are bullish on the broader deal market’s prospects in 2017 despite the uncertainty caused by the election of Donald Trump.

More regulatory oversight of international deals – particularly those emanating from China – was flagged as potentially problematic, but most dealmakers agree that any increased scrutiny would likely only delay deals, and that middle-market cities such as Los Angeles would be less affected.

“Cross-border deals are definitely going to go down,” Braun said. “They’re going to take longer and they’re going to be harder. But not in the middle market. Nobody cares about a middle-market buy into the United States (by a foreign company).”

In fact, many predict the Trump presidency could have a positive impact on the deal economy.

“I don’t think anybody knows what’s going to happen next, but my prediction is that M&A is going to increase under Trump,” Freedman said. “I think that he’s going to make this country mostly more business-friendly. He’s talking about reducing regulation for banks and other industries, which will have a positive effect.”

The greater concern is a larger economic downturn or some unforeseeable event that could torpedo the market. Even if such a scenario were to arise, most agree the region would weather the storm well.

“We have a very diverse economy,” Greif said. “Because it’s middle market, entrepreneurial driven … it’s very resilient. Companies get launched here, companies grow here, and then companies get acquired here.”

Indeed, players such as Greif and Freedman, who spurned big outfits to form their own investment banking shops in Los Angeles, said being outside the New York financial center has advantages.

“In terms of the deal world that I’m in, Los Angeles, for the number of companies that are here, is what I would call underbanked in terms of investment banks,” Freedman said. “It’s a great territory for doing deals.”

Los Angeles also lives up to the West Coast, entrepreneurial stereotype: It’s less concerned with pedigree and more with performance, according to Greif.

“Always been a show me what you can do type of town,” he said. “It’s a very open meritocracy and accepting environment for people going out and starting their own operations.”

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