Primary impacts from the war in Ukraine are few, but idiosyncratic effects widespread in the portfolio
Clearly, the eruption of conflict in Eastern Europe injected a significant measure of uncertainty into the macro environment. For the PE industry, first-order effects have thus far been relatively limited - PE investment in Russia has historically been de minimus, based on the complexities of the operating environment. Overall, PE activity in Russia and Ukraine represents well under 1% of the global activity, totaling approximately just US$4b over the last decade.
However, PE firms are actively working to understand the potential second-order impacts of the war in Ukraine, which are far more widespread. With portfolio companies around the world operating across a range of industries, the follow-on effects of sanctions, supply chain issues, banking disruptions, and higher commodities prices all have the potential to impact portfolio company KPIs, although these impacts will be highly idiosyncratic. This includes:
- Investments in the consumer and agribusiness spaces are seeing higher input costs pertaining to commodities, packaging material, labor, oil, and transportation.
- Investees operating in the industrials space that are dependent on Russian exports for metals such as nickel, platinum, cobalt, and copper could face disruption.
- The margins of specialty chemicals companies are being impacted by the price of crude, a crucial raw material for many.
In aggregate, PE firms have deployed US$1.1t in European assets since 2017, significant portions of which were allocated to companies in the consumer (17%), industrials (13%), and materials (10%) spaces – sectors that are being challenged by higher input costs. Firms are therefore busy revisiting the pandemic playbook, wherein they sought to assess and triage portfolio companies in order to respond first to those that were the most heavily exposed.
Also of significance is central banks’ reaction to the war in Ukraine, to the extent that the timing of potential rate increases (and PE’s cost of borrowing) is impacted, which could challenge more highly leveraged transactions.
What increased volatility might mean for deals
If history is any guide, PE firms will overall remain active. Often, macro disruption tends to shift firms’ areas of focus - in the early days of the pandemic, for example, with lending markets frozen and M&A activity effectively at a standstill, many firms shifted to credit investments and Private Investment in Public Equities (PIPEs). For example, in Q2 2020, with the pandemic-induced market dislocation at its peak, the number of PIPE deals effectively quadrupled from the average of previous quarters. And on the credit side, many PE firms acted quickly to invest in par recovery plays as widespread selloffs in the leveraged loan and high yield markets saw prices fall at a record pace.
Today’s environment is likely to see similar measures around strategizing for a market likely to be defined by different fundamentals than recent years. Recent weeks, for example, have seen a number of US take-private deals enabled by a market that fell 13% peak-to-trough.
Exit activity slows
Exit activity saw more dramatic declines than acquisition, based partially on its greater sensitivity to macro externalities. Overall, PE firms announced 296 exits in the first quarter of 2022 valued at US$109b, a decline of 55% by value from the same period last year. Exits declined across all types – sales to strategics fell 52% as potential acquirors stepped back in order to focus on potential disruptions to their core businesses. Sales to other PE firms fell by nearly 15%. Sales to SPACs, which at one-point last year accounted for transactions valued at more than US$41.4b, fell to just US$9b; and IPOs fell 94% from the first quarter of last year, with just two IPOs valued at US$2b occurring in the first quarter of this year.
