Podcast transcript: Why PE’s role in our economy and society is more important than ever

23 min approx | 30 June 2020

Winna Brown

Hello and welcome to EY’s Next Wave Private Equity Podcast. In our series, we explore the impact that private equity can have on the economy and society, capturing insights from industry thought leaders and private equity practitioners from across the globe. I’m Winna Brown from EY, and I’m your host.

Hi everyone, and welcome to the latest in EY’s Next Wave Private Equity podcast series. In today’s podcast, we will explore the impact COVID-19 has had on the private equity sector, as well as how the events of the last few months have shaped the future of the sector. I’m really delighted to have Andres Saenz with me today. Andres is EY’s Global Private Equity Leader. Welcome to the podcast, Andres.

Andres Saenz

Thanks Winna, happy to be here.

Brown

Andres, as you and I have spoken about, there was really no way at the beginning of 2020 that anyone could have predicted the events that have unfolded and the impact that the pandemic would have on our lives, both professionally and personally. And clearly, some sectors of the economy have been more impacted than others. Can you tell us, at a high level, how the pandemic has impacted the private equity sector?

Saenz

Sure. I mean there’s been, obviously, a significant impact, as there has been on other sectors. Initially, the immediate reaction, not surprisingly, was working to keep all of the employees safe, move to a transition to work from home. But then, beyond sort of that very immediate task, a lot of attention was placed on the portfolio.

So, going through the whole portfolio and seeing where do we have issues: issues around supply chain, issues around liquidity, looking for state aid and stimulus packages; all those things became pretty important. You know, you’ve got to think, in the portfolio, they have things like theme parks, restaurants, energy companies, health care companies.
Now, they’ll also have other things that maybe would have benefited from something like this, you know, consumer hygiene, online education, etc. That focus on the portfolio became, probably, the most important thing. And I think, as a corollary, to some degree, communicating with investors and LPs around what was happening with the impact on valuations and things like that. Through all of this, the one thing that really stopped was the deals. The deal markets basically shut down almost overnight. There were some deals in the pipeline; those were able to get done. But after mid-March, very few deals done; with the, I think, important exception around credit funds. This was a time when credit opportunities became important, and they went after them in a pretty significant fashion.

Brown

As you say, the private equity sector has definitely been impacted. I wonder if we can now shift our discussion, though, to next steps. And perhaps we can dive into the different key areas of private equity; so, if we think about it as investing, portfolio and fund. And each of them has been impacted in their own unique way. And so, their next steps will probably be very different. So, it would be fun to explore that a little bit. Let’s perhaps start with investing, if that’s okay.

Saenz

Sure. On the one hand, PE firms have been very well positioned for this, let’s call it for a slowdown. They’ve been preparing for the last two or three years. They have a lot of dry powder, and there were a lot of lessons that they learned during the great recession around this being a good time to buy, these types of conditions. Now, we have, specific to COVID-19, specific impediments to investing right now, or just getting deals done broadly.

One, the inability to travel creates issues around meeting management teams, doing due diligence, negotiations, etc. Two, the lack of available finance; if you’re a company with a strong balance sheet, high-yield markets are available. But on the leveraged loan side, the credit still hasn’t opened up. And then you have the valuation disconnect between buyers and sellers, and those things need to sort of come together a little bit more. Now, I think in the meantime, firms are looking to get creative around other opportunities.

For example, investments in public equities, I think is about one-third of the PE deal activity that’s happening; because these things are more volatile, there might be more opportunities that folks can get in on. Ares and Providence investing in Outfront Media, for example; Roark invested in Cheesecake Factory. I mean, there’s been countless examples of private equity companies looking at these public equities and seeing real opportunity. And then, as I mentioned, I think credit opportunities remain very active in the market.

Brown

Do you think then, based on this, that it’s fair to say that private equity will continue to invest through the current times and into the future? However, perhaps the pace of this investment will differ depending on the type of PE fund; as you say, is it a credit or is it public market? And also, the sector that they’re focused on may shift.

Saenz

My view is that, almost universally, private equity firms are looking to be as active as possible as soon as possible. Now, obviously, the pace and the timing, I think are open questions based on the factors that we talked about before: travel, credit, expectations. Barring a second wave of a pandemic, travel is slowly opening back up in certain regions; credit timing is still a little TBD. And I actually think buyers and sellers are going to converge sooner than one would think. And I think, given the levels of dry powder, that will push the dealmakers to meet the sellers sort of somewhere halfway, so to speak. Every sector is going through this idea of what is the new normal. These situations, when you have a new normal, when there is displacement and changed dynamics, it also creates opportunities for new winners. And I think our private equity clients are looking across sectors saying, “How am I going to play this sector?” “What are the new investment theses?” “What are the new opportunities?” And “How quickly can I get to work?” Both on new platforms, but I think this is also true of add-on opportunities as they jump in and say, “How do I make my existing portfolio stronger by maybe adding certain components that would give us a competitive edge?”

And then, the final, I think, opportunity that we’re going to start to see more of is carve-outs. You know, you’re going through, this displacement is affecting all sectors. And when you’re looking at sort of larger corporate holdings, and they say, “What’s strategic?” “What’s core?” “What’s non-core?” “What do I want to divest?” We expect it will be divestiture activity where private equity firms will be very actively pursuing these assets as well.

Brown

So, we think about private equity firms and how they’re pursuing assets and opportunities, let’s kind of shift the discussion now to a PE portfolio company. They’re normal businesses who’ve been impacted by the stay-at-home orders, they have disrupted supply chains, reduced demand, just like every other business out there. Do you think the fact that those that are PE-backed gives them an advantage as they focus on next steps to a back-to-normal state? And I guess, side by side with that, if you’re not PE-backed, would you be looking to be one of those companies that PE firms are looking to be opportunistic in? Is there an advantage to being PE-backed?

Saenz

I think it definitely gives them an advantage. And I think there are two sources to that advantage. First of all, I think it’s … let’s call it sort of capital, an investment. We saw this during the last downturn; PE-backed companies actually invested more relative than non-PE-backed peers, and again, because they have greater access to capital. So, that’s one, and that matters because you’re looking to shore up finances, you’re looking to take advantage of opportunities, etc.

The other one is the increase in operating resources that we’ve seen over the last 10 years within the private equity community. Almost 90% of PE firms have added significantly to their ops resources over the last decade. And so, those would be currently deployed across the portfolio. So, you know, basically you get a combination of capital and know-how expertise, and that gives folks a real leg up. And to answer your second question, Winna, absolutely. I think if you’re a company in market, let’s say a family-owned company, right now, you need both of those things. You’re probably going to need capital to take advantage of opportunities to shore up your finances. But you’re also going to need expertise in taking advantage of opportunities, whether it’s digitizing things, whether it’s entering adjacent markets, improving your sales force effectiveness, whatever it is. I think those things are going to become more important in the period of significant changes we’re living through right now.

Brown

And I assume it’s still fair to say, even in these times, that, depending on your PE backer, you could have a very different level of infrastructure or support system to help you through these times. Is that right?

Saenz

Yes. I think generally, the bigger funds have an ample mix of internal resources across various capabilities. And then they’ll use advisors like us for specific initiatives. I think midsize funds, smaller funds, maybe they rely a little bit more on advisors and sort of their own teams and their own management teams. But, yeah, I think there’s a spectrum. But again, I think where the industry is relative to where it was 10 years ago, vastly, vastly different. 

Brown

What are some of the unique challenges that PE fund managers are facing? And perhaps you can also share some interesting emerging trends that you’re seeing?

Saenz

Sure. I think as it pertains to the fund, one thing that’s good is the diversification that we’ve seen over the last decade. They’ve gotten into various asset classes and types of investing. And that gives them flexibility in an environment such as this one. So, for example, on the credit side, as we’ve talked about, 10 years ago they had 200 billion in AUM, and now it’s more than 800 billion. And obviously, we’ve seen them be very, very active on that front.

You mentioned emerging trends. I think one of the areas that we’ve paid particular attention to is sort of a new found emphasis on talent. It’s always been important, but it’s become sort of top of the agenda. Private equity firms will ask themselves, “Do we have the right enablement, given the needs for a more resilient organization?” “What is the role of technology?” “Do we have the right skills?” You know, I think private equity needs a broader range of skills than they did in the past, whether it’s … particularly around technology, I think, computer science, AI, et cetera. And then, “Do we have the right value proposition in this day and age to recruit the best people?” And then you’re talking about a generation, particularly millennials, that want to work for a purpose-led organization.

And then, I would say, more broadly, are the private equity firms fully representing and engaging all of the vast stakeholders? This is where things like the elevation of diversity and inclusiveness where, I think, private equity has historically performed poorly on, takes on a different level of importance and awareness in this day and age.

Brown

Andres, these are really interesting trends. We have a focus on talent, technology, value proposition and purpose-led organizations and D&I. Do you think this is linked to signals that private equity might have had from their LPs? And do you think that the way PE complexes are reacting and dealing with and addressing the impact of the pandemic is influenced by the LPs and how they see the future of private equity? And then, I guess a connected question is, whether the pandemic has actually impacted the ability of private equity to raise new funds from LPs.

Saenz

Let me start with the latter. I think, not surprisingly, there’s been an effect on fundraising. But more along the lines of processes getting pushed back, or not operating as quickly, although really, the bigger funds have been able to maintain, let’s call it, sort of virtual fundraising processes, pretty effectively; because they’ve built the trust, they have the track record. I think for new funds, etc., it’s obviously more challenging to sort of build those relationships. But this  environment favors the larger, more established managers. But all in all, longer term, LPs remain very committed to the asset class.

Now to your point, Winna, and the first question, they want the financial returns, but they want the private equity firms to be aware and driving through all of the different stakeholders, creating as much value as they can. And that takes on the form of purpose, that takes on the form of talent and D&I, that takes on the form of the engagement of the workforce on the portfolio side; all of these things are going to matter. But LPs, I think, in general, have stated that they remain committed to the asset class; they remain committed to working with private equity firms on this front. And more broadly, I think there might be a widening of the aperture of who those investors are, you know, certainly in the US, the current conversations around the potential investments of folks’ 401(k)s into PE vehicles as one extra form of investor capital.

Brown

That’s good. So, we’ve got the LPs that are committed to the asset class and the future of the asset class. Let’s kind of unpack a little bit more about the trends that you’re seeing. You and I have had previous conversations, even before the pandemic, around long-term value, and how private equity is really uniquely positioned to create value, not only from a monetary or ROI sense, but also, importantly, from a societal perspective.

You could say that the pandemic has provided an opportunity for private equity to really demonstrate how they’re focused on their broader stakeholders, including their employees and the consumers of their products. And, ultimately, that they’re committed to making a positive impact in their communities. I guess what would be interesting to see, if you have any specific examples of how you’re seeing private equity actually bring that to life in these days?

Saenz

I think private equity firms, particularly the more progressive ones, view this environment as a real opportunity to make good on that promise to have a broader sort of social responsibility. And so, in the short term, I think they’ve been very active in aggressively responding to the crisis. For example, setting up employee assistance programs; in some cases, taking reduced salaries themselves; donating PP&E and other equipment. There was a PE-backed mattress company that donated hundreds of mattresses to New York-area hospitals, for example; or even backing companies that are actively seeking treatments or vaccines.

So, they’ve been very active in doing sort of their part in their local and national communities. Beyond that, the crisis and the events accelerated the trends that we’ve been talking about: the increased transparency, increased sustainability, accountability for private equity investors to all stakeholders. As we discussed, the investors sort of demand it, but private equity firms themselves see the real value in doing so. And so, they’re responding in many different ways on a go-forward basis, continuing to think about impact funds and socially focused pools of capital; being more proactive around measuring, monitoring and reporting the full range of externalities and value that they create.

And going beyond sort of traditional concepts of ESG; I think at EY, we’re real believers in the notion of long-term value in that framework. And you see private equity firms really embrace sort of that broader view of their impact on … their economic impact, but also financial impact, societal impact, etc.

Brown

And I guess the pandemic, which, you know, has impacted our lives in so many negative ways, the focus on long-term value and the ability to speed up that trend is potentially a positive. When we look back on this time, perhaps private equity firms and others will be seen as responding in a very positive way to the events of today by focusing on the community and focusing on improving the lives of their stakeholders, which is a good thing.

Saenz

Agreed.

Brown

So then, if we focus on the other trends we’ve seen in the sector, being digital and technology, truly, you’d have to say that the pandemic has also sped up the move toward automation. When we’re working from home without our computers, I don’t know what we would do. And clearly, we’ve seen across the landscape that those businesses who’ve already embraced technology prior to the pandemic had an easier time in adapting to the challenges of remote working or social distancing versus those businesses who potentially have not yet started their digital journey.

It would be interesting to explore, perhaps, some of the unique ways that you’ve seen digital technologies transform the private equity sector. And perhaps we can focus beyond the obvious kind of back-office efficiencies that technology brings.

Saenz

I view this as a trend that was happening and only gets accelerated and magnified sort of post-COVID, post-recession. I agree, I mean there is a back-office component to this. You can think of sort of robotic process automation, anything that sort of adds flexibility to the staffing model and enables sort of greater productivity and efficiency within the workforce that you have. But I think there are more interesting applications, as you mentioned.

You just think about deal origination and, for example, the use of artificial intelligence to surface opportunities and trends that become investable themes and, ultimately, companies that they can put money behind. That’s one application. You think about the portfolio and thinking through deeper data analytics into financial and operating metrics of their portfolios, so they can identify opportunities and risks in real time, so they can leverage insights from one portfolio company to another. I mean, these are the things that create real differential value by being part of a private equity complex, and that private equity firms have been paying attention to, but they haven’t sort of reached that holy grail of being able to leverage this technology in a really great way.

But I think they’re going to start to move much more aggressively in that direction as they continue to seek opportunities going forward, and differentiation going forward as well. In the end, though, I think this may end up being a great opportunity for private equity to continue to evolve and create more value than ever. It’s a good time to invest, as was proven in the last great recession. It’s a really interesting opportunity for portfolio companies to take share and win in the marketplace, given all the shifting sands and their particular industries and sectors.

And it’s the time for private equity firms to really deliver long-term value for all of their stakeholders, including finding that right mix of talent and technology to ultimately deliver as much value as they can. It’s a really, really interesting opportunity that I think private equity leaders recognize and are being deliberate in how they pursue it, because I think the ones who get it right, across a lot of the dimensions we talked about today, will ultimately really benefit going forward and their ability to continue to raise funds, put money to work, hire the right and diverse group of people, and create as much long-term value for all stakeholders as possible.

Brown

One of the trends that you touched on earlier on, that may be worth exploring a bit further, is the newfound emphasis on talent; private equity needing to now kind of question, “Do we have the right skills to take us to that next level?” “How is my renewed focus to purpose-led viewpoints going to attract a new generation of employees?” “How is the changing supply chain and changing global dynamic going to change my hiring habits?” And, of course, D&I, very strong focus on D&I to be embedded in everything they do. Any thoughts on how, I guess, the pandemic and the times we’re in are really accelerating that move to the talent agenda?

Saenz

I think it’s top down. We’re still going through a generational change in leadership succession at some of the private equity firms. And, as that change happens, and then you combine that with external conditions of the types that we’re facing now, even intrinsically, private equity firms are becoming bigger, more complex, and they’re pursuing these value levers that we’ve been talking around digital, etc. It just changes how you think about the talent in the organization.

And I think, over the last 10, 20 years, private equity firms have been relatively homogenous in the talent that they pursue and put to work. Whereas, in reality, I think you’ve seen it over the last few years, but you’re going to see it a lot more going forward, a broadening of the type of talent that you need from the funds, to the deal teams, to the operating companies, to portfolio management teams, both in terms of skills, in terms of technology acumen, and again, importantly, in terms of diversity and inclusiveness. And I think private equity firms recognize that they’re in the middle of this pretty momentous shift and will require a lot of attention and very deliberate strategies to make sure they get it right. But, ultimately, I think the ones who do get it right, they’ll have a very differentiated position in the market and will be in a better position to continue to raise funds; deploy capital; and create better, longer-term value.

Brown

Absolutely. Andres, thank you so much. We really appreciate your insights and your perspective on what the future holds for private equity. And, as we discussed, while the events of the last few months have definitely been unexpected, there’s a number of meaningful trends that are emerging, which are probably going to shape the future of private equity in the months and even years to come. I guess the question now is, how well private equity complexes keep up with the pace of change, and how quickly the changes will actually take root within the sector. I guess time will tell.

Andres, thank you again for your time, and I look forward to catching up again very soon to see how the rest of the year pans out and, ultimately, how the sector unfolds and grows in the years to come.

Saenz

Thanks, Winna. My pleasure, as always. 

Brown

To our audience, I hope you enjoyed this episode of the Next Wave Private Equity Podcast and that you found it to be informative and interesting. Please subscribe, review and, of course, share it with your colleagues and friends. To find out more about the topics we discuss, check out EY.com\privateequity. I’ll see you on the next episode.