Podcast transcript: PE Pulse: five takeaways from 3Q 2023

8 mins 56 secs | 25 October 2023

Pete Witte

Hi, everyone, and welcome to the latest edition of EY’s PE Pulse podcast. Over the next eight minutes or so, we’ll give you a rundown of all the important themes and trends in the private equity space, and we’ll share some views on how the macro environment is impacting private equity. My name's Pete Witte, and I'm part of the PE group here at EY.

Thanks so much for joining, and let’s get started! 


Let's start with a look at deal activity. We seem to be coming into a part of the cycle now where some of the macro uncertainty that we’ve seen is starting to recede a little bit, and that abundance of caution that we saw last year and in the first part of this year, you know, it’s starting to give way a little bit toward more of a risk on stance for a lot of the firms out there.

And we see that reflected in the deal activity out there, so the value of deals has remained pretty much constant over this year — about US$100 billion every quarter. But the number of deals has climbed significantly from the beginning of the year until now. Sponsors announced 93 deals in Q3 — up more than 60% from the first quarter of this year. 

And the reason for that — the reason that volumes have gone up, but values have stayed the same — is that the type of deals that we're seeing is evolving. The market is broadening — today, we're seeing more secondary buyouts, we’re seeing more bread-and-butter acquisitions of private companies, and especially, we’re seeing more carve-outs. Of the top 20 deals announced in the third quarter, one-third were carve-outs. And for PE firms — especially the big ones — those deals can be competitive differentiators. It can give them an opportunity for them to leverage their scale and their operational expertise to drive real value.

That’s in contrast to the first part of this year, where we saw an almost exclusive focus on take-private deals; something like 70% of the value that was deployed in the first quarter was into these big take privates. 

So, the market’s getting broader, and I think that’s a sign of increasing health — that said, there are still challenges out there, and it really boils down to three things.

One of the things that we just did — we went out and took a representative survey of private equity investors across geos and across firms of all different sizes. And we asked them what major impediments to doing deals right now. 

The first thing that they all said was uncertainty around the macro environment — no surprise there. The second was around cost and availability of credit; again, I'm not surprised. The third was around high valuations and a lack of compelling assets for sale — and I think that's a theme that we frequently hear — that only the best assets are coming to market, and the competition for those deals remains very high.

For those assets, that valuation gap has been minimized. For that next tier down — assets that are a little more complex, that are going to require a little more work — that valuation gap remains a little wider, and so those are a little less likely to trade right now. And I think that's what must happen for the market to resume in a more fulsome way.

But I think that process is underway — as part of that survey, we also asked folks what they expected their deployment activity to be over the next six months. A small minority — about 13% said they expect to pull back; about 20% said it’ll be about the same; and the majority — about two-thirds — said that they expect to increase deployment activity over the next six months and, in some cases, significantly. 

So, I think the picture that's starting to take shape is around a steady increase over the next several months until we reach full “normalization.” And, of course, all the usual caveats here apply with respect to macro and unforeseeable externalities — but that looks like the path we’re headed on.

From a sector perspective, tech remains an area of focus— last year, it was about one-quarter of activity by value; this year, it's about one-third, driven by some of those big take-private deals that we saw in the first part of this year. 

Going forward, health care is one of the spaces where we see a lot of activity headed — going back to our survey, 60% of our respondents saw a greater emphasis there, and about half of those folks thought that increased attention would be significant. Energy was another space that jumped out, and so was tech, and so was financial services.


Now let’s talk about exits for a little bit because what’s interesting things that we’ve seen here is that while we’ve seen signs of recovery here as well, it’s not quite at the same level yet as what we’ve seen on the acquisitions front. So, in our survey, about one-third of firms said exits would increase, about a third said they’d decrease, and about a third said they’d stay the same. So overall, just a little less conviction there. Now, that market recovery will certainly occur with moderating inflation and declining interest rates. The conditions for it are right, and firms must be ready for that, but it probably trails the buy-side by a few months, and that recovery will be more than welcome. 

Right now, for example, according to Cobalt data, distributions as a percentage of NAV are at low levels. If you're an LP and you have $100 invested in private equity, in an average year, you'll typically get $20 to $25 back in distributions. Last year, you got $15 back; now, you're getting about $7. And the rest of that capital remains locked up in the portfolio. So, you see a lot of experimentation with alternative sources of liquidity — and we’ve talked a bit in the past about the interest out there in secondaries and continuation vehicles — that continues.

More recently, you have heard a lot about NAV loans, which allow funds to borrow against the value in the portfolio - in some cases, to facilitate liquidity for the LPs. I’ll share one of the interesting use cases here that I heard recently, was around firms using NAV loans to buy LP interests in their funds — so an LP puts a fund interest for sale on the secondary market, and the fund, instead of letting that interest go to a new LP buys it back for the fund — essentially, you're doing a stock buyback at the fund level. So, again, just a lot of innovation and GPs trying a lot of different things to get that capital unlocked and back into the hands of their investors. 

And that's important because what ultimately impacts the fundraising market — about 80% of private equity's capital comes from those reinvested distributions. Now, PE firms have plenty of runway — right now, there’s more than US$1.3 trillion in dry powder that’s out there and available to do deals — but as the exit markets get more active, the fundraising markets pick up, and that whole flywheel starts to move faster.

Value creation

Last thing I'll mention is around the value creation piece. We know that operational value add is the key way that private equity firms add value to their portfolio companies — and as the cost of capital goes up, as hold periods get extended, and as the IRS start to come under pressure, that operational piece becomes ever more important. And so, as part of our survey, we asked firms — what levers are you really focused on right now?

Top-line growth — always front and center. But beyond that, firms identified two areas where they say they’re more focused than usual. The first, probably not surprisingly, is cost takeout. Seventy percent of the private equity firms out there say they're more focused on cost initiatives than usual. And as they do that, the key is taking a thoughtful approach that keeps costs under control while keeping the growth drivers intact. 

The other is liquidity and working capital — this was the number one answer — 80% of the private equity firms that we surveyed indicated that they're paying more attention to working capital and helping their portfolio companies get visibility into their portco’s cash needs, and to free cash where it's available. We recently conducted a study, for example, of 1,500 US and European companies. We found total excess working capital of more than US$2.5 trillion over and above what’s required to operate those businesses efficiently — and that’s cash that could be used to fund acquisitions, repay debt, fund business transformation or invest in talent — all at a time when a lot of your competitors are on their back foot.

That's our time for today. Thanks for joining and be sure not to miss next quarter's podcast as well — we'll be doing a year-end wrap-up and give our outlook for 2024.