Right now deal flow in the world of Private Equity is going through the roof. Pre-pandemic the amount of dry powder in PE coffers was valued at over a trillion dollars. While some of this has been used to shore up portfolios and weather the COVID storm, there is still significant capital to deploy. Add to that the low cost of borrowing, then a sharp increase in deal activity was going to be inevitable.
But, there is a lingering concern. Is the combination of a seller’s market and a voracious appetite to do deals and secure assets on the PE side leading to uncharacteristically hasty deal execution. And, if so, what are the consequences?
We’re already seeing wild fluctuations in valuations and delays in deals being completed. This is largely driven by lack of sell-side preparation, challenging levels of access to management and detailed information, leading to an insufficient understanding of the ‘real’ pre- and post-COVID performance of the asset. We regularly see this in carve-outs, where a clearer picture begins to emerge post-Day 1, as we covered in our recent Carve-outs webinar, often leading to a reassessment of the value creation plan.
In some ways it’s similar to the current housing market. Both are benefitting from state relief / incentives and this is causing a rush to complete deals before the doors slams shut. In both cases, haste seems to be prevailing, leading to inflated prices, an absence of the typical rigour we’d expect to see in normal conditions and, longer term, limited potential to create value from the asset. As with the housing market, where sales are falling through when mortgage companies fail to endorse the buyer’s valuation of the property, we’re also seeing deals fall down.
Part of the challenge in establishing the valuation is in getting a solid understanding of the impacts of the ‘COVID effect’ and the potential it has to distort the real underlying cost base. With discretionary spend reductions, rent reliefs, furloughing and hiring avoidance all creating artificially lower costs, new owners are at risk of a ‘COVID snap-back’, which may seriously inhibit value creation opportunities. On the flip-side, if new owners can find ways to make these temporary efficiencies sustainable as part of the new operating model, there’s a real opportunity to create a more efficient cost base for the future.
The reality is that these outcomes can be avoided – in part at least – with some thorough ‘outside in’ work and an awareness of this unique market dynamic we see across businesses. In this information-rich age there is typically sufficient intelligence available to get to 60%-70% of the picture before initiating the deal.
As with so many things in life and private equity, proper preparation prevents… well, you know the rest.