Podcast transcript: PE Pulse: five takeaways from 2Q 2023

8 mins approx | 31 July 2023


Welcome to the EY NextWave Private Equity podcast, where industry leaders come together to discuss emerging opportunities and industry trends shaping the global private equity landscape.

Pete Witte

Hi everyone, and welcome to EY’s NextWave Private Equity podcast. Over the next eight to 10 minutes or so, we’ll break down some of the most important market trends and themes in the private equity space and how some of the macro dynamics that we’re seeing right now are impacting the way that PE firms transact, raise capital and exit their investments. My name’s Pete Witte and I’m a director here in EY’s Private Equity group, and let’s get started.

You know it is hard to believe that it’s midyear already, yet here we are. It’s been about 12 to 15 months now where we’ve been in this slower environment for deals, and all that time, you know, we’ve been looking at activity and trying to figure out where the turn in the market is going to be. Now, I don’t know that we’re quite there just yet, but there are some interesting things that are coming out of the last few months that I think are worth looking at.

So, specifically, we know when we look at deal activity, we’ve seen a little bit of an uptick over the last three months. Second quarter of this year, PE firms announced deals valued at about US$115 billion. That’s a 15% increase from the first quarter of this year. It’s up almost 20% from the last quarter of 2022. A lot of that was driven by a steep increase in Europe in particular. Last two to three months, PE firms have been more active there than they have at any time over the last year. So, there’s some changes, and I think some positive changes, in terms of the trends that we’re seeing with respect to the volume of deals that are out there that are happening. June was especially active, US$42 billion, second busiest month of the last year. There are also some interesting changes that are happening with respect to the types of deals that we’re seeing. You know, you might recall that for the last several months we’ve been talking about how the market’s been dominated by take-private transactions. In a normal year, take-privates are about 20% of total PE activity by value. Last year, they were about 40%. In their first quarter of this year, they were almost 70% of total PE activity by value. We had never seen that level of take-private activity before. Well, what’s happened in the market over the last, let’s say three to four months or so? We’ve seen some significant rallies in the global equities markets, especially in the US where a lot of this activity is centered. So, in the US, for example, S&P 500 was up 8% in the second quarter and so a lot of that bargain hunting that firms were engaged in is starting to recede a little bit and so now those take-privates are down to about 40% of activity. Still high relative to historical standards, but we’re not where we were six months ago. So, what have we seen instead? Well, we’ve seen more secondaries. We see more carve-outs. We see more acquisitions and private companies. Just sort of this broadening, right, in terms of the types of deals that are out there happening, which I think is probably healthier for the market, you know. You think about the real impediments to dealmaking over the last few months and obviously the financing markets have been a big one. But beyond that there’s just been this persistent disconnect in valuations where sellers want one price and buyers are willing to pay another. And so, I think this broadening is evidence that that gap is finally starting to narrow a little bit and that sellers, in particular, are kind of reconciling themselves to the current market environment and outlook. And we’re starting to see that same dynamic on the exit side as well. Exits have been extremely quiet for the last year.

But in the second quarter, we saw a modest uptick, so firms announced transactions valued at about US$84 billion in the second quarter — that was up more than 40% by value from the first quarter. We saw a significant uptick in sales to strategic acquirers. Those grew 90% from the first quarter. And while the IPO window is still pretty much closed, you know, we’ve seen a handful of PE-backed deals come to market in recent weeks and the pipeline there continues to build. It feels like sentiment is changing and I wouldn’t be surprised if we saw additional IPOs in the coming weeks, assuming of course, that the strength that we’ve seen in the public markets continues to hold. In the meantime, we continue to see shops looking at alternative sources of liquidity. So, there’s a survey from Coller Capital, for example, that was just released. Found that more than three-fourths of LPs attendees secondaries to help generate liquidity over the next couple of years and fundraising for vehicles that are focused on that space is on pace for a record year. And that’s in sharp contrast to what we’ve seen in the fundraising market more broadly. We’ll talk about that in just a minute. So, there’re evolutions here that are allowing for increased liquidity, despite some of those challenges in traditional exit routes. And that’s critically important because distributions to LPs right now are at some of their lowest levels since the financial crisis. So last year, just 14% of NAV was returned to investors vs. a long-term average of around 25% and what that ultimately impacts are the fundraising market, right? About 80% of private equity’s capital comes from those reinvested distributions and as those drop significantly it gets harder and harder to raise new funds. And to that end, we’ve seen about a 16% decline in fundraising in the first half of this year relative to the second half of last year. Now, all that said, PE firms still have plenty of dry powder to deploy, right? They have about US$1.3 trillion right now that they can use to fund new deals. So, where’s that leave us, you know? Where do we go from here? And I think it’s a great question, you know? We’ve been in this space for economists have been calling for recession for, you know, well over a year now? But macro performance has remained resilient, right? It was only a year ago when inflation was running at, you know, 7%, 8%, 9%. That’s moderated significantly and for the most part it’s happened without the dramatic impacts on unemployment that we thought will come along with it.

The exogenous shocks that we saw several months ago when the banking system had been managed effectively and at least so far without that systemic contagion that we were really worried about and so we’re kind of locked into this liminal space where there’s this continued uncertainty around the outlook, especially around interest rates, and that’s keeping a lot of folks in wait-and-see mode. It feels like a little bit of that uncertainty is starting to wind down a little bit, you know? That confidence is starting to grow, but I suspect that we’ll have a better sense of the market’s trajectory over the next three months or so, insofar as whether we see a significant uptick in the later part of this year or whether a more fulsome recovery doesn’t really kick off in earnest until 2024. And in the meantime, I think we’ll see private equity firms continue to focus on doing what they do best in times like these, which is opportunistically invest in high-quality assets in spaces with clear long-term secular tail winds. So, software, for example, media, logistics, health care — they’ll continue to focus on asset classes that are benefiting from today’s market environment. So, secondaries, for example, like we talked about — but then also, you know, especially private credit and I think most importantly they’ll continue to focus on creating value in the portfolio, you know. At some point, probably in the next several months, the exit window will reopen again, and firms want their portfolios positioned as well as they possibly can be for potential exits. And so that means streamlining the business to maximize those operational efficiencies, but also focusing on topline through supply chain improvements, through pricing optimization, through digital transformation and just a wide range of growth numbers. So that’s it for today. Thanks, as always, for listening and I will see you next quarter with another update.


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