Times they are a-changing

Private equity funds get creative during macroeconomic uncertainty

GROWING concerns about the state of politics in major markets as well as fears over a potential recession are the biggest challenges currently facing the private equity (PE) industry, according to Global Private Equity Outlook 2020.

Published by law firm Dechert in association with Mergermarket, the survey indicates that formerly niche strategies are becoming commonplace as the industry adapts to an overabundance of capital, with buyout practitioners moving into growth capital and minority stake investing as well as raising long-hold funds.

In Asia-Pacific, Chinese PE activity is likely to remain subdued until the country reaches a trade accord with the US. China’s loss is, in part, benefiting other countries in Asia – in particular, Vietnam has made meaningful gains, opening its borders to foreign investors and establishing itself as a regional manufacturing hub.

“The slowdown in the Chinese economy continues to have a dampening effect on its neighbors, particularly those which heavily rely on trade with China. Coupled with the drop in the level of Chinese investment and acquisition appetite in the region, valuation expectations in parts of Asia-Pacific are starting to fall,” says Singapore-based Dechert PE partner, Siew Kam Boon. 

“For certain funds and their portfolio companies, this could present unique opportunities, particularly if the target company possesses strong fundamentals,” she adds.

In North America, deal activity growth in 2019 raises the question of how long activity can continue to increase in PE's biggest, most dynamic market, and what could possibly derail it? For 40% of respondents, the 2020 presidential and congressional elections are the developments most likely to impact dealmaking in the near future.

Nearly half of respondents (48%) said they plan to diversify their asset class exposure without a doubt over the next 12-24 months, and another third (32%) said they will most likely do so.

New York-based Dechert PE partner, Markus Bolsinger, explains that, “Faced with geopolitical and macroeconomic headwinds, the short-term outlook for private equity is less rosy compared to this time last year, however private equity as an asset class will continue its successful march.” 

“The best performing private equity managers, whether through creative deal sourcing, strategic partnering, or innovative monetization of their investments, will raise ever larger pools of capital and diversify into additional asset classes,” he adds.

The top-cited fundraising challenge among respondents was the trend of large Limited Partners (LPs) concentrating their investment relationships to a smaller number of funds (27%), reflecting in part the rise of mega-funds and the dominance of top firms when securing new investments.

There are also high expectations for carve-outs, with the majority of respondents surveyed anticipating an increase in the number of such deals. The primary driver will be the need to spin off business units in order to pay down debt. After a decade of the loosest monetary policy in history, which corporates capitalized on by taking on record levels of cheap financing, this cycle could potentially come to fruition – although not as quickly as first envisaged.

In the EMEA region, buyout activity has remained robust despite the looming prospect of Brexit and the unknown consequences of the UK's departure from the EU. Looking ahead, Brexit remains the biggest potential barrier to investment for PE firms in EMEA over the coming 12-18 months, as cited by 57% of respondents investing in the region.

London-based Dechert PE partner, Ross Allardice, explains that, “While the past decade has seen substantial dry powder being built up by sponsors, high valuations mean it remains a struggle to put that money to work effectively and requires a more creative approach by sponsors to investing money.  As such, traditional PE funds are moving into growth capital, minority stake investing and raising long hold firms to differentiate themselves.” 

Private equity has never had more capital at its disposal, and it will take years for dry powder reserves to be processed. This may be the industry’s new normal. Deal activity, meanwhile, has never been higher, at least in the core North American market. But there is no guarantee that dealmaking activity will sustain such levels in the short-to-medium term.

In spite of having the wherewithal to transact, all GPs are focused on the geopolitical climate, and time is ticking on this historical period of business expansion. Fund managers have no choice but to continue being creative making deals and seeking profitable exits, regardless of forces in the outside world.

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Date

16 Oct 2019

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