The once-in-a-century pandemic-induced economic downturn has disrupted private equity’s usual business strategies but has opened new opportunities at the same time. We are seeing PIPE deals on pace to raise more money than any year since 2008 and buyouts up year-over-year so far, as the industry seeks to maintain a flow of investments in new targets and also to keep pre-pandemic portfolio additions afloat and profitable.
Debt for Buyouts Less Available & Cheaper
Leveraged buyouts at the usual levels of private equity skin-in-the game have become somewhat more difficult because debt for deals has become harder to acquire. General partners may have to make a bigger investment than they have been used to (reducing leverage and, consequently, potential returns) to secure buyout financing but private equity is also likely to benefit from borrowing at historically low interest rates.
According to Antoine Dréan, chairman and founder of private equity fund advisory Triago, firms are seizing the opportunity. While other investors prefer to stay on the sidelines during this economic upheaval, private equity firms are buying at valuations representing deep discounts from 2019 levels. Investment in distressed companies is likely to surge. Cash-strapped public corporations have recently been finding traditional financing harder to secure or simply unavailable. Private equity is moving in to fill that need for both distressed and healthier public companies.
Buyouts Are on the Rise
In fact, in spite of the financing difficulties being faced, year-to-date, private equity M&A market share and buyout volumes remain solid. Before the pandemic, there was an aggressive outlook for private equity M&A—and, even now, the outlook isn’t all that bad. Relative to the shrunken size of the M&A pie, private equity is still maintaining its big slice, and it may even be growing. In 2019, the industry’s deals represented 26% of all announced global M&A volume. By comparison, even though global M&A has slowed significantly, the industry’s market share has gone up: In 2020, private equity deals represent roughly 30% of all global M&A volume.
Private equity buyout volume is also on the rise. $101.3 billion in proposed, pending, and completed private equity buyouts have been announced in the U.S. this year, which represents a 15% increase from the same period last year.
While private equity may not see the “extreme money-making” of past years, the industry is continuing to make deals and is poised to seize upon targets with lower multiples, cheap acquisitions that may provide big returns down the line. Specifically, private equity is likely to have a significant role in acquiring targets in suffering industries that are predicted to undergo significant consolidation by way of M&A.
PIPE Deals See Renewed Interest
In this environment, private investment in public equity (PIPE) is seeing renewed interest and activity. Recent PIPE deals have involved dining and entertainment restaurant chain Dave & Buster’s, online real estate services company Redfin, online car seller Carvanna, and payment company EVO. Most, if not all, of the companies seeking PIPE financing this year are doing so in response to the severe disruption, if not complete shuttering, of their businesses.
PIPE deals offer more expensive financing for public corporations and therefore are disfavored by them—except during times like these (and the 2008 Financial Crisis), when traditional financing is limited.
Private equity firms are likely to experience downward pressure on their investment returns until the economy regains its footing. The industry may have to temporarily lower its expectations for returns and be nimble in adjusting its strategies in its hunt for yield. However, the industry experienced similar difficulties during the 2008 Financial Crisis and went on to post stellar post-Great Recession returns while substantially extending its reach into nearly every corner of the economy. Scott Conners, president of PE firm FlowStone Partners, explained that performance is cyclical. Money invested in the past three years will struggle in the current environment, but money invested tomorrow should do well.
We are starting to see some changes that may signal a strategy shift by private equity to help struggling portfolio companies amid the crisis. Additional Stake purchases by private equity investors are up by count and volume compared to same period last year and second- and third-round fundings are also up from last year. Both are ways to inject cash into companies that need it most now.
There are also reports of private equity sponsors exploring alternatives to funding through new equity, such as through issuing a new layer of secured debt on top of existing loans or bonds. But helping portfolio companies is also in the interest of the funds. Private equity firms are currently facing serious drops in the value of their existing assets. Consequently, profits already paid to a fund’s general partners risk being subject to clawbacks, and their funds risk falling out of carry (like recently happened to four of Carlyle’s funds). When this occurs, funds’ general partners are no longer able to earn carried interest because of the funds’ failure to meet performance thresholds.
Saviors, Vultures or Neither?
An extended period of cheap money, light-touch regulation, and a record-smashing bull run for stocks supercharged private equity’s returns over the past decade. This, combined with high valuations and fierce competition for target companies prior to the pandemic, left the industry with an unprecedented amount of unspent cash on hand at the start of 2020. At the beginning of this year, private equity had around $1.5 trillion in dry powder waiting to be invested.
As always, private equity’s reputation is problematic. While newly proposed long-shot anti-monopoly legislation targets “private equity vultures,” some believe that private equity could use present opportunities to “emerge from the crisis with an enhanced reputation for creating value and minimizing risk.” With private equity money being injected to many sinking businesses during this difficult time, it is certainly an opportunity for an image upgrade.
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