Getting over the deal (and exit) drought
Will deal and exit activity pick up in 2024 and 2025?
Rapidly rising interest rates and a generally uncertain outlook dampened investor enthusiasm for pursuing investments last year, with a clear impact on exits as well as new transactions. Indeed, in 2023, total global private equity deal values sunk to their lowest level in five years, according to S&P Market Intelligence.
This year seems to have got off to a better start, with global private equity deal values increasing by 9% in the first six months of 2024, according to figures reported by BCG. But what do LPs and GPs make of where the market is at currently?
“Volumes have been down by 40-50% versus previous years,” says Barnaby Lyons, Partner and Global Co-Head of Bain Capital Special Situations. “That’s because public equity markets are almost as high as they have ever been, and their valuations don’t reflect the full set of risks we see today. At the same time, credit is at one of the most expensive levels it has been since the Global Financial Crisis. Expensive equities and a high cost of financing is why we are seeing such a big bid-ask spread in private equity and that is affecting deal activity.” He adds that this creates opportunities for special situations and for differentiated private equity strategies.
Many believe that acceptance of higher interest rates and an expectation that economic Armageddon is unlikely are starting to filter through to the market. “There is a general sense that things have stabilised,” says James Pitt, Partner at Lexington Partners. “Inflation is more stable, interest rates appear to have peaked, and economies are moving in a more positive direction. Deal flow appears to be picking up – we’re seeing this in co-investments.”
“In the past year or two, recession was everyone’s base case and that makes it hard to underwrite new deals,” adds a European managing director at an investment management firm. “This meant that only the most pristine deals got done, with companies transacting at strong prices. The environment today appears to be one where a soft landing is the base case and where scenarios are a bit more predictable – that opens up space for more assets to transact. Not everything will get over the line but there should be more eagerness to try.”
Many believe that acceptance of higher interest rates and an expectation that economic Armageddon is unlikely are starting to filter through to the market
Yet it will take some time yet for sellers of anything other than these pristine assets to gain confidence that their transaction will complete, suggesting that both new deals and exits may not pick up markedly for a while yet.
“The market has changed,” says Colm Lanigan, Global Head of BlackRock Long Term Private Capital and CIO. “People are being very careful about what they sell because they don’t want a failed process and price discovery is not as robust as it used to be. When people are selling, they are not going to 100 firms, they are rather testing the water with five to six possible buyers.”
If firms want to deploy capital in a market like this, they need to look beyond the highest quality assets, digging deeper to find opportunities, says Rich Lawson, Co-Founder and CEO of HGGC. “Deals are getting done,” he says. “But they are smaller in number and trading at very high premia – the rest of the market is not moving. There is almost a checklist today of what private equity is looking for. So if you want to avoid all that competition, you need to rotate away from this sameness and find the deals that are hidden gems.”
And when it comes to exits, private equity is going to have to sell the less than perfect portfolio companies at some point. “Firms need to sell their so-so companies, says Michael Lindauer, CIO Private Equity at Allianz Capital Partners.
“Last year, everyone thought that interest rates would come down significantly and they might be able to wait it out and weather the storm. But it is now sinking in that this is the environment we are in and that some target returns might not be met – it’s not great, but it’s not the end of the world.”
And finally, while LPs clearly want to see their capital both deployed and returned – and there is some pressure on GPs to achieve both of these – a slower deal pace may be no bad thing overall, according to the managing director. “The dislocation has introduced soberness for many managers,” she says. “It has slowed down deployment pacing and there is more thoughtfulness around investment cases. GPs realise that if debt is not cheap and they can’t rise rising multiples, the thesis has to come back to the basics of company operational improvement and transformation – they have to sharpen their pencil and figure out what to do with the business. That is healthier and the current vintages should be better overall than the previous few years.”
