5 minute read 12 Feb 2020
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How PE is preparing for a wide range of future macroeconomic scenarios

By

Andres Saenz

EY Global Private Equity Leader

Trusted advisor to leading private equity professionals and their portfolio companies. Ardent student of consumer behavior. Marathoner. Family man.

5 minute read 12 Feb 2020
Related topics Private equity

After another strong year in 2019, 2020 is poised for continued growth.

We expect overall PE activity to remain strong in 2020. 2019 was a strong year from a fundraising perspective, albeit slightly off the high-water mark of 2017. While valuations and the challenges in deploying capital continue to raise concerns among some LPs, any hesitation in committing fresh capital is being offset to a degree by entirely new investors that are moving into the space. Indeed, high-net-worth individuals (HNWI) and family offices now account for 15% to 20% of new money coming in at some of the industry’s largest firms. Thus, the secular nature of these asset flows should make them somewhat insulated from the credit cycle, and we’re therefore bullish on continued strength in inflows.

From a deal perspective, deployment remains challenging. Currently, competition for deals is pushing multiples well above the top of the last cycle. In the US, purchase multiples have reached 11.5x (versus 9.7x in 2007), and 11.1x in Europe (versus 10.3x in 2007). As a result, firms are seeking “clearer air” by moving downmarket into the growth capital space, where growth rates are higher and there are increased opportunities for operational value-add. The largest firms are leveraging their size to move up market into large take-privates and complex carve outs where their scale is a differentiator. It’s a dynamic we expect to continue barring exogenous shocks.

Global PE deals

US$249b

in PE deals announced globally last year.

Geopolitical developments will continue to shape the dispersion of activity. In the US, for example, activity has continued largely unabated, driven by a strong macro backdrop and accommodative lending markets. PE firms announced deals valued at US$249b, up 3% from last year, making it among the most active year since the global financial crisis (GFC). With valuations continuing to converge between the public and private markets, take private deals will remain a source of opportunity for funds. Add-on activity will also continue, although buy-and-build as a strategy has become increasingly challenged as high valuations permeate deeper into the middle market.

Firms are seeking ‘clearer air’ by moving downmarket into the growth capital space, where growth rates are higher and there are increased opportunities for operational value-add. The largest firms are leveraging their size to move up market into large take-privates and complex carve outs where their scale is a differentiator. It’s a dynamic we expect to continue barring exogenous shocks.

In the UK and the rest of Europe, activity was muted in 2019, which saw PE firms announce deals valued at US$159b, down 12% from 2018. However, with fundraising strong — firms headquartered in the region raised US$162b last year — and Brexit moving toward a final, albeit messy conclusion, dealmakers are likely to see a reappearance of compelling opportunities, particularly in take-private transactions and distressed opportunities. In Asia-Pacific, the ongoing trade dispute between the US and China is disproportionately affecting the China market, a theme that could persist. However, the degree to which activity remains predicated on the domestic growth story means opportunities will continue to remain robust in less export-sensitive industries; consumer spending in China is currently growing at 10% per year, more than double the rate of the US.

Interest in impact to accelerate

The trend toward increased interest in impact-oriented investments is expected to continue. For many years now, PE firms have been identifying, managing and tracking Environmental, Social and Governance (ESG) factors across the full life cycle of their investments; now, however, many are moving beyond the “do no harm” mentality of ESG and are actively working toward creating positive social change through their investments. Last year alone, according to the Global Impact Investor Network (GIIN), impact investors put more than US$5b to work in PE investments.

2020 should see even more capital devoted to the space, and more investments in businesses with a high social value-add. Exit activity will remain market dependent. 2019 saw a measure of caution in the IPO space, as investors pushed back on the valuations of many unicorn IPOs. The pipeline remains robust; however, investors will be increasingly focused on fundamentals and the long-term sustainability of business models. Trade sales should remain active, as will exits to other PE funds. Moreover, the rise of the LP secondary market is providing new options for LPs seeking liquidity. Five years ago, this was approximately a US$26b market — now, activity is pushing US$100b.

PE firms prepping for a range of macro scenarios

One significant open item is the overall economic outlook and the way in which that might impact PE activity. The last decade has been one of unprecedented growth for private equity. Since the GFC roughly a decade ago, the size of the industry has more than doubled. However, we now enter a period, where the outlook is more mixed. On one hand, we have a picture of robust, albeit slowing growth. On the other, mounting concerns around the potential for a widespread economic downturn driven by geopolitical instability, pockets of market excess and the overall length of the current economic expansion. Indeed, one of the lessons from the last crisis was that while PE acted quickly to protect its portfolio companies (as evidenced by the relatively few defaults among PE-backed business), it was too conservative in deploying additional capital on new platform investments and add-on transactions. Should the market turn, we expect the industry to view it as a buying opportunity, and to deploy rather aggressively. With more than US$740b in dry powder at its disposal, it is better positioned than ever before to execute on these ambitions.

Summary

Fundraising remains strong for PE firms, while deal activity continues to be challenged by high valuations. As 2020 unfolds, PE firms are preparing for a wide range of macroeconomic scenarios.

About this article

By

Andres Saenz

EY Global Private Equity Leader

Trusted advisor to leading private equity professionals and their portfolio companies. Ardent student of consumer behavior. Marathoner. Family man.

Related topics Private equity