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Hi everyone! My name’s Pete Witte; I’m the Lead Analyst for Global PE here at EY, and you’re listening to the PE Pulse miniseries on EY’s NextWave Private Equity Podcast. And over the next few minutes, we’ll talk through some of the things that we’re seeing in the market here at EY, and we’ll keep it short and sweet - what are the 4-5 things that you really need to know around what’s going on in PE right now.

Besides the podcast today, we’ve got a great written report as well that talks a lot of this in more detail – and to see that, you can just visit ey.com/PEPulse.

So let’s get started.  

Macro themes

First off – I’m going to preface this by saying this quarter’s podcast is going to heavy on the macro environment – because that’s really what’s top of mind for investors right now. You think about private equity and the period in which it really came of age – and let’s say that’s been roughly the last 15 years or so – from a macro perspective, the bulk of that periods was – for the most part – characterized by strong growth, low inflation, and low interest rates.

And now we’re heading into a period where that may be changing. To what degree, and for how long, we don’t yet know. And that uncertainty is going to impact both the outlook for new deals, and the way that PE firms interact with their portfolio companies.

PE activity softens in Q1 from last year’s breakneck pace

So let’s unpack this; and we’ll start with deals. I think anyone who is in or adjacent to the PE industry knows that last year was an absolutely tremendous year for PE. We saw record levels of activity, and PE passed the US$1t mark for the first time ever in terms of the total value of deals that were announced. We actually closed out the year with US$1.2t in deals. And part of that was pent of demand from the pandemic – markets shut down, people couldn’t do deals, and when it reopened, deals were hard to price because you didn’t really know what the outlook was. And that sort of resolved over the course of last year, and you had this tremendous rebound in the M&A market – and PE was a big part of that.

So we sort know going into this year that some measure of softening was probably on the table. And that’s exactly what we’ve seen. Q1 of this year, we saw deals announced worth about US$220b; and that a decline of 27% from the first quarter of last year.

What I’d like you to take away though, is that this level of activity, is still very robust. In fact if it were to keep up at this level – and we’ll talk in a minute whether or not that’s likely – it would be the second busiest year on record, behind last year. So it’s still been really busy, just not quite at the breakneck pace of last year.

And to me, one of the things that was really interesting – and maybe even telling – was that the pace at which capital was deployed in Q1 remained relatively steady over the course of the quarter; in January, we had US$70b in deals announced; in February, it was about $80b, and in March we had another $70b. So just really consistent throughout the quarter; we didn’t see a drop-off in March like you might expect, and I think that’s because the deals that were in the pipeline at that point were far enough along that they were able to go through despite the geopolitical turbulence that we saw beginning in late February

And so it will be really interesting to see what happens over the next month or so, with deals that aren’t as far along; and the degree to which some of the atmospherics that we’re seeing now start to impact that.

Geopolitical uncertainty and the impact from the war in Ukraine

Primary impacts

Which takes us to the war in Ukraine and the impact of that. And we’re going to separate this out into primary impacts and secondary impacts.

And the primary impacts are actually pretty limited – if we look at PE’s investment activity in Russia, and the Ukraine as well, there’s really not much there. I counted deals worth about US$4b over the last ten years. Now, maybe there’s more than that, things that aren’t being reported – but that’s sort of the magnitude. And to put that in perspective – over the same time period, PE firms have done deals valued at about US$5.6t across the rest of the world. So in the scheme of things, it’s well under 1% of global PE investment activity, and you haven’t really seen any of the large global firms being active there.

And then there are a few other first order effects – specifically, where firms are double-checking their investor lists to make sure they’re not dealing with any sanctioned individuals; and then for some LPs, a handful have announced that they’re divesting from Russian assets entirely – so any funds that do have exposure, and have capital from those LPs, then they’ve obviously got to address that.

But by and large, those situations are really on the margins.

Secondary impacts

What’s more important for PE firms are the second order impacts – PE firms manage somewhere around 20,000 portfolio companies around the world – and so the follow-on effects of sanctions, the supply chain issues, the banking disruptions, the higher commodities prices - all of these things have the potential to impact portcos. And the nature of those impacts is going to be highly specific to each company. For a European manufacturer that relies heavily on commodities inputs, there’s likely some significant headwinds; or for a consumer products company that’s sensitive to energy prices, same thing. In the banking sector, you’ve got disruptions to asset flows. The bottom line is that firms are doing the same thing they did during the pandemic – it’s the same playbook – where you’re going through one-by-one, you’re understanding what your exposures are, and you’re triaging in order to respond first to those that are most significantly impacted.

And then the other open item is really what happens with respect to inflation and interest rates. And the beginning of the year, this felt like it was pretty well mapped out. Now that’s in flux and so to the extent that rate increases – which of course impact PE’s cost of borrowing - are delayed, reduced, accelerated, increased – that could impact the pace of deployment for the rest of the year.

Exit activity slows

Beyond that, there are a couple of other things worth mentioning

The first is around exits. Exits have seen more dramatic declines than we’ve on the acquisitions front, based partially on exits’ greater sensitivity to macro externalities. We saw exits valued at US$288b in the first quarter, that was down almost 60% by value from the first quarter of last year.

I think a few dynamics at work here – for strategics, they’ve sort of stepped back in order to focus on potential disruptions to their core business. SO we’ve seen declines there. I think what’s probably more interesting is the dramatic declines we’ve seen in public market exits – IPOs and sales to SPACs.

Last year, sales to SPACs of PE-backed business was about US$150b. First quarter of this year – US$9b. And that’s because the PIPE financing that’s needed to support these deals has stepped away for the time being, and the investors in the SPACs themselves are choosing to redeem their shares rather than enter into new deals, because the market’s been so challenging. And not’s not a dynamic that’s limited to private equity, that’s across the board. But it is effectively closing off SPACs as an exit route.

It’s a similar dynamic in the IPO market – last year, PE backed companies raised $110b in IPOs – first quarter of this year, US$3b. So the window’s just not open right now.

And so in the meantime, PE firms will continue to do what they’ve always done, which is continue to execute on the strategy, and when the conditions are more amenable, they’ll look to exit.

Secondaries market reaches new heights with GP-led deals being key drivers

Last thing I want to briefly touch on is the secondaries market – because that market is playing a bigger role than ever in the PE ecosystem, and that’s going to be the case regardless of what happens from a macro perspective. You look back ten years ago, and that market was pretty immature – there was limited liquidity, and the sellers that were there were often distressed. Today, it’s whole different story - more than US$100b in fund interests changes hands each year. At one time, most deals were led by LPs seeking to offload their interests; today, GP-led secondaries – where a fund is saying, hey, we think this asset has some additional runway and we’d like to hold it for longer - account for most of these types of deals. And so for the LPs, they provide optionality – those that want to continue with the asset can, while those that want liquidity are able to achieve it. With firms raising returning to market faster than ever to raised new funds, that optionality has become more important.

And I mention this because whatever happens from a macro perspective, the secondary market’s going to play an important role. If volatility recedes and the market stabilizes, then we likely see more continuation activity. If the opposite occurs and fundamentals deteriorate, then you have LPs looking to rebalance their portfolios. And so a lot of money has been raised for this market, and for very good reasons.

So those are some of the key dynamics from the first quarter – some measure of softening on the deals front – but still an overall very active market, and firms trying to understand all the moving parts of the macro environment, and what that means for deployment and their portcos.

Thanks for tuning in, we’ll see you next quarter. 

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