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The Great Comeback

Asset managers seeking to invest in the retooling of the global economy to facilitate the energy, mobility, or food transition have had many opportunities to buy into assets with high growth prospects. But few of them have been profitable and cash-generative.

 

The time required to produce net cash inflows has proven to be long for several reasons, including intense global competition, scalability issues, outsized R&D expenses, or significant capital expenditures. From an investor perspective, the difficulty in identifying the ultimate winners and assessing the potential profitability at maturity has contributed to making it hard to build conviction around value.

 

If 2021 saw more than $600bn invested in start-ups, financial performance and rising real rates have weighed on their attractiveness. Global start-up funding sunk to a 5-year low in 2023 with less than half the amount raised two years earlier. ARK Innovation, a proxy for the valuation of companies involved in disruptive innovation, has seen its valuation decline by 70% since its peak in February 2021. Meanwhile, the broader FTSE Renaissance IPO index is down more than 40%.

 

Ultimately, successful leaders in these new markets will be handsomely rewarded and able to consolidate their industry.

 

Meanwhile, a new variety of firms is emerging, as witnessed, for example, in the industrial (capital) goods world. Unlike the young players in new tech, they rely on traditional technologies, including mechanical (e.g., heat exchangers, air distribution, backup power generation) and electrical (e.g., uninterruptible power systems, transmission & distribution equipment) engineering.

 

Until recently, they were typically growing at a low single-digit rate and generating EBITDA margins in the low to mid-teens while being subject to economic cycles. As a group, they have been shunned by investors who have instead been prepared to pay a premium for growth since the Great Financial Crisis.

 

But the world is changing. The decarbonization, electrification, and digitization of the global economy drive a paradigm shift expected to lead to a generational capex cycle.

 

Fast-growing new technologies (including, but not limited to, artificial intelligence, renewables, and energy storage) are pulling ‘value’ plays with them. Traditional technologies in capital goods are visibly assuming a critical transition-enabling role and reaching the status of high-quality ‘growth’ plays with profitability levels supported by newly-found pricing power.

 

Because these businesses have been around for more than a century, they also benefit from defensive features: reputable brands; scale and market power following years of industry consolidation; a large installed base; stable industry structures; deep domain expertise; established regulatory regimes; a reliance on mature technologies; and longstanding relationships with relevant stakeholders.

 

This breed of assets is presenting new investment opportunities in M&A and the public markets.

 

Like Taylor Swift sang in Willowat a fabulous concert in Wembley on Friday: ‘They count me out time and time again/But I come back stronger than a 90's trend.’

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