Mark Veldon
London
My last outlook for the latter part of 2023 pointed towards the need for Private Equity to think differently and reassess the prevailing market dynamics in an effort to counter the economic constraints that hit deal flow so heavily.
Moving into 2024, while many of the macro factors that dampened dealmaking activity persist, I can see shoots of recovery and expect the market to come back to life in the 12 months ahead.
The status quo that we saw in 2023 cannot go on indefinitely, and Private Equity’s realignment has brought widespread appreciation that interest rates and financing costs will remain high for some time. Accepting this landscape as a “new normal” should kick-start deal flow once more, albeit with associated challenges to overcome in getting the market moving again.
Many PE firms are now embarking on fundraising, but in order to do so they need to deploy capital. Although there have been a limited number of processes recently, we know that many PE firms have portcos ready for exit.
The significant mismatch in bid-ask spreads in the past 18 months has extended many hold periods well beyond what was originally planned – allowing enforced operational efficiency and margin improvement efforts to apply a renewed lustre to these assets and heighten their appeal in a reinvigorated market. And again, of course, PE firms need to exit to generate returns to support financing.
I also expect public-to-private opportunities to remain popular – listed companies are open to going private in the current environment in pursuit of greater flexibility and the ability to generate greater returns. Green shoots are on the horizon, in my view.
Maturities still loom large
However, the industry cannot ignore the maturity cliff that continues to cast a long shadow over any potential uptick in activity this year. Refinanced debts that are soon up for renegotiation have sounded alarm bells for many firms, and I expect extensions to dominate activity here, in addition to continuation funds and fund-to-fund investments.
Credit funds will also continue to pick up the keys on lower performing assets via debt-for-equity swaps. While the quality of the assets acquired in many of these instances could be somewhat obscure, they should still be well positioned to ride out a cycle of recovery, growth, and exit over the next two to three years.
I also highlighted last year that sector consolidation could be on the rise, and this is a trend that we have already seen play out in Brookfield’s acquisition of Oaktree, General Atlantic’s pending acquisition of Actis, and Astorg seeking a buyer for a c.€2bn sale just before Christmas.
Valuation recalibration is key
Valuations will be critical in catalysing the resurgence in dealmaking that the industry so desperately needs. With the cost of financing so inflated, there is a general assumption that they will have to come down to better match operating conditions. However, with that burning need to deploy capital and an increased availability of assets for the reasons mentioned above, any renewed optimism around economic recovery will no doubt instill a level of competition in every process that pushes valuations back up. There will be a delicate balance to strike here to avoid another bout of prolonged stand-offs and market inertia. Overall, I’d expect valuations to stay high, but they’ll still be some way off the peak that we saw a few years ago.
If this proves to the case, world-class due diligence will come to the fore, and will likely separate the winners from other market players. Many were burned by a lack of this discipline in the post-pandemic fundraising and acquisition frenzy, but now the need to double down on diligence couldn’t be clearer. It should be noted that many European funds have lagged their American counterparts in sector knowledge, largely driven by inherent market fragmentation across Europe, but several funds have used the last 18 months to pivot and develop dedicated market expertise, whilst also exiting consumer-exposed sectors, which will serve them well as deal flow returns.
If premium prices stick around in an economic environment that leaves traditional dealmaking or value creation strategies a little hamstrung, potential growth opportunities in a business must be rigorously validated. For example – what impact could AI have on the business or sector in question? And what can be done today to reduce costs, yet still position that business for growth in years to come?
I see a year of growth for Private Equity in 2024. An industry-wide reality check for Private Equity should set the wheels in motion to turn a vicious deal dampening circle into a virtuous dealmaking one. That won’t eradicate the bad deals from the good, though, and firms must still tread carefully to make the right moves on the road to recovery.