While the amount raised and invested by private equity funds capped six years of unprecedented growth in 2019, the health and financial crisis brought about by Covid-19 has put paid to the idea that the good times might continue into the new decade.

Certain trends – such as increasingly picky LPs and the incorporation of ESG, P2P, buy and build and extension of share ownership – should intensify in the aftermath of the pandemic, while others – the surge in the value of multiples, jumbo funds, increase in leverage – are likely to fade or disappear completely.

It might seem like an age ago, but back before the coronavirus – and its attendant consequences for the world of investment – hit, the PE industry seemed to be in decent shape. But while capital amassed remained at a high level, a plateau had, in fact, been reached and the industry was almost certainly entering the end of a cycle.

Survival of the fittest

In 2019, institutional investors deployed $894 billion in private capital through private equity, real estate, infrastructure or natural resources funds. If that amount was a slight increase on 2018’s $861 billion, it nevertheless failed to threaten the high water mark of $930 billion in 2017. Only the buy-out segment has continued an upward trend since, registering $361 billion in engagements – the best performance in this category since records began.

Another characteristic of private equity in 2019 was the speed with which deals were concluded, with 70% of GPs concluding their leveraged buyouts in less than twelve months! The availability of cheap debt, one of the main drivers of PE activity, even led to a number of GPs putting together jumbo-funds – Advent ($7.5bn), Cinven ($11bn), Thoma Bravo ($12.6bn), TPG ($14bn), Permira ($12bn), for example – which goes a long way to explaining this phenomenon. In any case, happy are the managers who closed their outstanding deals before the turn of the year, because it will take some time to before PE reaches such elevated levels again. This is due to Covid-19 yes, but not entirely.

"Given that PE was performing at historically high levels in relation to other asset classes before the pandemic, LPs will be unwilling to turn their backs on this type of activity"

At the start of April, around the time the gravity of the pandemic was sinking in, 3,620 investment vehicles were at the commercialization stage. That is not a negligible amount and points to a fundraising logjam: between January and March, only 267 GPs managed to close their investment vehicles, and only 52% of these took less than 18 months to finalize – two metrics that were well down on previous years. In Europe, for example, Apex paused its buy-out vehicle at €1.2 billion in order to allow however much time was necessary to reach the hard cap of €1.5 billion.

Given that PE was performing at historically high levels in relation to other asset classes before the pandemic, LPs will be unwilling to turn their backs on this type of activity. That said, nothing is stopping them from reducing their exposure. And they seem to be doing just that. Preqin recently revealed that 56% of LPs prefer not to invest more than $50m in any one non-listed fund (up from 47% the previous year). What’s more, as one mid-cap manager told Leaders League “LPs prefer to analyze the share portfolio reports of their GPs rather than explore new investment opportunities at the moment, with fundraising activities postponed, at the very least.”

This wane in optimism looks set to reinforce the current hyper selectivity of LPs, where a ‘winner takes all’ logic informs their choice of which transactions to pursue. As Bain & Co. partner Jérôme Brunet explains, “a large percentage of the capital being raised is concentrated in a small number of funds.” To put it another way, never have so few GPs raised so much money in so little time. This trend, which began well before Covid-19 hit, has led to the accumulation of unprecedented levels of dry powder among leading private equity firms like Warburg Pincus, Platinum, KKR and Apollo

Deals: back to normal valuations soon?

A tempting logic is leading firms to think about valuation multiples in relation to Ebitda generated by the investments of private equity funds. Namely that valuations are set to continue to decline for months to come, and, following this line of thought, if turnover continues to collapse, it will eat up all or the majority of expected profits. The reality, however, is more complex.

Still, lacking clarity on how the economic relaunch is going to pan out, for investors it is time to take a wait-and-see approach to making investments. “Only deals that are at a very advanced stage are being closed at the moment,” adds Brunet. Indeed, many negotiations that were in their infancy when the crisis struck have since been postponed, because the interests of the seller (who wants a valuation based on pre-virus ebitda levels) and the buyer (who prefer to assign value based on ebitac – with the ‘c’ representing the coronavirus and its impact on economic activity) stand little chance of being in alignment in the current climate. But as summer turns to autumn, something will have to give.

And then there is the sectoral aspect. The coronavirus has pushed values both up and down depending on the sector. According to Refinitiv, a financial-markets analyst, companies in the healthcare, high tech and consumer goods sectors are now valued at more than 18 times their ebitda, while companies relying heavily on the physical presence and efforts of their workforce, such a construction businesses and brick and mortar stores – not to mention financial firms – have current ebitda multiples of less than seven. Those companies hardest hit by the crisis currently have a coefficient of only 1.7.

The main reason for this is, of course, is the lockdown, wherein measures taken by governments across the world to curb the spread of the virus put sectors dependent on physical activity into a state of suspended animation.

All these depreciations have had a ripple effect throughout the global M&A market. For example, when it comes to an LBO, the ebitda multiple of a European company sits at 8.8 today, compared to 10.9 in 2019. And for Céline Méchain, the managing director of Goldman Sachs France, “If the fall in prices continues, it is not beyond the realm of possibility that new, value sharing clauses, between buyers and sellers will be drawn up, in order to find some middle ground. We can also expect to see an explosion of earn-out clauses, with financial clauses, for the most part, needing to have a flexible conversation rate depending on the KPIs of the target.”

In addition, independent from the debate about Covid-19 winner and loser sectors, we will need to wait until the level of competition regarding the most qualitative assets is sufficient high once more, i.e. regarding primary LBOs, scalable activities, fragmented markets etc

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