5 minute read 28 Apr 2020
Stock exchange market display screen

How private equity is responding to COVID-19

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 28 Apr 2020

As COVID-19 continues to impact us all, businesses are faced with more uncertainty than any period since the global financial crisis.

As an industry with more than US$3.4t in AUM that employs more than 20m people across the world and owns companies across a wide range of industries, PE is positioned to feel the full gamut of effects from across the portfolio, including the need to find new ways to execute on deals.

There is no question the rapid progression of the pandemic and the resulting shock to the markets has been unnerving for the PE industry. A few interesting data points emerged during the course of our Capital Confidence Barometer Survey, which took place 10 February—24 March, 2020. Their responses over that period reveal the breaking realization of one of the most violent and impactful global crises of the 20th century. (Download the full report: PE Pulse April 2020.)

In February, despite one of the longest bull markets on record, and a number of macro indicators flashing red for the global economy, only a minority were modeling a recession to hit in 2020. However, by mid-March, as the global scope of the crisis became known, the proportion jumped to two-thirds.

Similar impacts are seen on measures of confidence. When asked whether their firm was more prepared for a recession than it was a decade ago, a resounding 93% replied that they were. However, as it became increasingly apparent that the current recession would be unlike any other experienced before, confidence began to slip, with 23% signaling they were perhaps less prepared for COVID-19 than for the financial crisis of 2008.

Similar trends can be seen in sentiment around the preparation of the industry at large, the relative discipline in dealmaking and the ability of deals to withstand a downturn.

The flip side, or course, is that despite evidence of declining sentiment, a strong majority of PE professionals remain convinced that the model remains robust, and that the industry remains well-positioned to adapt and respond, even after knowing (or at least having strong indications of) the massive amount of disruption that was poised to occur and that is still unfolding.

Consequently, most PE professionals are expecting some measure of decline in deal activity – although the overwhelming majority of respondents feel it will not exceed 25%.

Indeed, while the coming months will test the model in ways that it’s never before experienced, firms are working diligently to manage the crisis and communicate with investors.

In February, only a minority were modeling a recession to hit in 2020. By mid-March, the proportion jumped to two-thirds.

Now – a focus on the portfolio

For most funds, tackling thorny issues at the portfolio level is the first priority. Firms are setting up crisis management teams; they’re working to model downside scenarios, optimize cost structures and working capital. In some cases, they’re diversifying their revenue streams and preparing for longer hold periods.

The nature of the crisis means that there are critical factors that PE funds and portfolio companies need to consider. More specifically, supply chain issues across the portfolio, ensuring sufficient liquidity and working capital across both the portfolio and at the fund level; working with companies to revise strategies and pivot as needed for an unpredictable operating environment; and understanding the wide range of tax issues that are arising out of the proliferation of government stimulus.

Assessing supply chains

Firms are performing supply chain intelligence and analytics exercises to understand where constraints exist, what their options are and how to build better communication between network nodes. Firms are helping companies to dynamically optimize where necessary, and to perform integrated planning and supplier management.

Strategy refresh and revenue impacts

Firms are working with companies to understand if the current strategy still makes sense in today’s environment. Are there things companies are doing within their existing footprint and revenue strategy that need to be accelerated and adapted? Are there potential supply and demand gap dynamics that need to be addressed, and if so, what are the options? Is a pivot in the company’s strategy required, such as a shift from brick-and-mortar to a heavier online presence, and if so, what elements are required to execute?

Understanding liquidity needs

For many portfolio companies, a combination of immediate higher cash needs and a limited ability to fund them can lead to liquidity shortfalls. Firms are helping to better identify portfolio companies with short- term to medium-term cash needs, and the size of those needs over the next several months under a range of different scenarios. For some, corrective actions will be available, while others may require additional equity from the sponsor.

Tax impacts

Firms are also working to understand the tax implications of the downturn and the full range of legislative responses across the world. In some cases, firms are acquiring the debt of their own portfolio companies, which can trigger tax consequences. In addition, tax filing deadlines are being moved and legislature is changing week to week.

Value creation

While many firms have mobilized large teams of operating partners, the scale of the disruption has seen them inundated. Teams are helping management to frame issues in a way that enables them to make smart and fast decisions around people, facilities, operating arrangements and technology. Agility and teaming are the new norm.

Summary

With deep benches of operational knowledge, PE firms can help their portfolio companies prepare to mitigate the impacts of COVID-19. Moreover, with ample stores of dry powder, PE firms are well-positioned to provide capital and expertise at a time when many companies need both more than ever.

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.