Private Equity Pulse: Five takeaways from Q3 2023

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rivate equity (PE) deal activity continues to accelerate as firms get greater visibility into interest rate trajectories and macro volatility begins to recede. In the third quarter, PE firms announced deals valued at US$101b — roughly consistent with the first two quarters of the year. However, the number of deals continues to climb substantially from what now appears to be the Q1 trough — sponsors inked 93 deals of US$100m and above in Q3, a 63% increase from the first quarter. 

Today’s market is seeing a broader array of deal types, in contrast to the first half of this year, which was characterized by a very narrow focus on take-privates and add-on transactions. Recent months, for example, have seen a number of large carve-outs from corporate parents seeking to divest non-core or orphan assets. Of the top 20 deals announced in Q3, approximately one-third were carve-outs, with an aggregate value of nearly US$25b (in contrast, Q1 was just 5% carve-outs). For PE firms — especially the largest funds — these deals can be competitive differentiators, providing opportunities for firms to leverage their scale and their operational expertise to drive value. 

Market participants are increasingly bullish on the prospects for rising acquisition activity as some of the fears of a deep recession that dominated the discussion last year and into early 2023 begin to abate (albeit with the caveat that downside risks remain). Recently, EY surveyed a representative sample of PE investors across geographies and fund sizes. Two-thirds of respondents expect activity to accelerate further over the next six months; just 13% expect a decline. 

Tech remains key sector for PE, but investors increasingly seeking to focus on health care

From a sector perspective, technology continues to be a key area of focus, accounting for nearly one-third of PE activity by value over the last 12 months, up from 26% over the preceding 12 months. Investors remain attracted to the industry’s long-term secular growth story, its relative resilience in the face of macro headwinds, and the growing integration of technology in sectors such as health care, finance, industrials, energy, and others. Investors are exploring verticals including anything-as-a-service (Xaas), TransitTech, HealthTech, RPA, advanced CloudTech, and others.

Over the last 12 months the health care sector has accounted for 10% of private equity investment by value, up from just 6% over the preceding 12 months — that focus is expected to accelerate. Sixty percent of respondents to the EY PE Pulse Industry Survey anticipate a greater emphasis on the sector. Core spaces such as pharma, and its potential for tech-led value creation via genomic data analytics, digitization, supply chain fragmentation, and the automation of critical processes, as well as newer niche spaces including med spa, specialized women’s health care services, and others, will continue to garner interest from PE.

Exits recover, albeit at a slower pace than acquisitions

Exit markets have shown similar signs of recovery in recent months, albeit at a slightly slower pace than acquisitions. In the third quarter of this year, PE firms announced 68 exits via M&A, up from 47 in the first quarter of the year, and up from 57 in Q2. 

Working capital and cost initiatives are areas of elevated operational focus 

For firms’ existing portfolios of assets, one of the primary consequences of extended hold periods is imperative to optimize operational value-add to offset longer ownership periods. Even for new acquisitions, with many assets continuing to be “priced to perfection,” there is little wiggle room for suboptimal execution. 

While firms continue to execute across the full range of value creation levers, the specifics of today’s operating environment mean certain initiatives in particular are taking clear priority:  

Liquidity and working capital: 80% of the PE professionals surveyed indicated they’re paying more attention than usual to helping companies get visibility into cash and liquidity needs. It’s a critical endeavor — in today’s market, portfolio companies that can create more cash are not only better positioned from a resiliency perspective, but also from an offensive perspective, insofar as they can deploy excess cash to fund acquisitions, repay debt, invest in talent or fund business transformation at a time when many of their competitors are on the back foot. 

Cost initiatives: Cutting costs is another area of focus, with 70% of firms saying they’re paying more attention to cost takeouts than usual. For those firms, a thoughtful approach that keeps costs under control while keeping growth drivers intact is imperative. 

Key questions for today’s PE market environment

- What sectors, verticals, or themes offer the best value? The greatest opportunity for growth? 

- What should firms be doing now to prep their portfolio companies for a more robust exit environment? 

- How can investors identify excess working capital and put it to work effectively?

- Are our cost reduction initiatives eliminating resources we’ll need for future growth? 

Managing liquidity and working capital

Working capital and cash management are critical levers — firms and portfolio companies need exceptional visibility into their cash and liquidity needs. Firms can focus on three key areas to build the cash discipline and control needed in today’s markets.

1. Get a firm grip on cash. While cash flow forecasts are a requirement for most businesses, they’re not always deployed effectively. A short-term direct cash flow forecast built from the bottom up, with a weekly cadence of variance analysis, reforecast and mitigation actions is most effective.
2. Manage working capital more effectively. Many PE-owned businesses have followed typical cash improvement methods such as extending supplier terms, running down old stock or factoring some of the debtor book. But these barely scratch the surface — instead, holistic tools that give the business exactly the information it needs, exactly when it needs it — can optimize performance. 
3. Tap into treasury team excellence. Treasury teams should focus on optimizing the liquid nature of the firm’s cash position through cash pooling, releasing trapped cash and flexible financing structures; and where applicable, have strong visibility and control of credit covenants and regulations across jurisdictions.

The next steps are to decide on the scope, intensity and timing of cost initiatives, followed by a determination of the areas of the business that should be targeted for improvement.