Private equity developments: What's trending now
Macroeconomic conditions have become increasingly volatile, leading to a decrease in private equity (PE) deal value and count from 2021. However, PE remains resilient, with 2022 being the second-best year for performance and 1Q23 metrics above pre-pandemic averages. Key trends include deposits diversification and stability, portfolio company value creation, first-out last-out (FOLO) unitranche facilities, investor preferences in larger and more diversified funds, and secondary liquidity trends for sponsors. Sponsors and portfolio companies are focusing on liquidity and excess deposits solutions like money market deposit accounts (MMDAs), money market funds (MMFs), and insured cash sweep (ICS) accounts. PE firms are also concentrating on value creation through technology, human capital, and environmental, social, and corporate governance (ESG). Investors are shifting their focus to larger funds and being selective in choosing sponsors. The private secondary market continues to evolve, providing alternative liquidity options for both limited partners (LPs) and general partners (GPs).
The new math of private equity value creation
It highlights the evolution of private equity and its role in investors' portfolios and how private equity has adapted its value creation playbook over time, shifting from leverage and financial structuring to multiple expansion and operational factors. The industry has generated 15% internal rates of return over the past 10 and 20 years, but performance has varied across managers and macroeconomic cycles. In the upcoming era of slower economic growth, shrinking labor forces, and higher inflation, operational value creation levers like revenue growth and margin expansion will become the main determinants of success. It also emphasizes the importance of technology, strategy, and execution in driving returns and the need for innovative capital structures and long-term time horizons to weather challenging environments.
Source: Goldman Sachs
Market Opportunity/ Challenges
Reflecting on challenges and opportunities for private equity
It discusses the challenges and opportunities for private equity in the current market, featuring insights from Valentin M. Pfisterer at Ashurst, Matthew P. Salerno at Cleary Gottlieb Steen & Hamilton LLP, and Jan Schubert at Gibson Dunn. The key themes driving PE include demographic development, energy transformation, and technological advancement. Deal activity has declined significantly due to factors such as the war in Ukraine, disrupted supply chains, inflation, and rising interest rates. However, there has been increased focus on ESG matters. PE firms are adapting to the nuanced risk landscape by exercising caution in target selection and comprehensive due diligence. The article also highlights the impact of legislative and regulatory initiatives on PE investments, particularly in the climate tech sector. In terms of exits, the decision-making process has become more complex due to internal and external factors. The experts expect macro-trends and developments to continue shaping PE investment activity in the short and medium term.
Source: Financier Worldwide
Private credit outlook: Room to run
There is high impact of rising interest rates and the retrenchment of banks on investment opportunities. Over $1 trillion of household deposits have left the US banking system, leading to banks reducing lending and facing higher capital requirements. Public markets are shrinking, and companies are seeking alternative sources of capital. This creates opportunities for investors in opportunistic credit strategies, discounted consumer and commercial loans, and asset-backed lending. The commercial real estate market also presents opportunities, particularly in multifamily and industrial buildings, data centers, and European office spaces. The growth of direct lending offers long-term opportunities as banks continue to retreat from lending. Clean energy financing is another area of potential growth, with private investment in renewable energy projects offering more direct access to the decarbonization transition. The private assets will play a crucial role in helping investors navigate the challenges of slower growth and higher interest rates.
What’s next for private lending?
The rise of private credit began after the Global Financial Crisis, as banks shifted away from private lending due to regulatory changes. Non-bank lenders filled the gap, leading to significant growth in private credit assets under management. Today, the market environment raises questions about how private loans will fare in the face of higher interest rates, slower economic growth, and the reopening of capital markets. In an interview with KKR Global Head of Private Credit Dan Pietrzak, he expressed optimism about the environment for private lending in the coming years. He believes the current market is one of the best lending environments since the Global Financial Crisis, with higher reference rates and more lender-friendly terms. He expects this favorable environment to last for years, as private equity firms have plenty of dry powder to fuel transactions. He highlights the importance of being selective and diligent about diversification in managing risk. He also emphasizes the focus on larger borrowers, as they tend to have better management teams. The most attractive sectors include software, business services, and insurance brokerage, while healthcare and cyclical sectors pose risks. He believes the growth rates of 14%-15% a year in private credit since the Global Financial Crisis are sustainable, as the market has evolved to address larger deals and more borrowers are attracted to the private debt market.
European private equity in 2023: a broadly positive outlook despite economic headwinds
The European PE industry faced a slowdown in the first half of 2023 due to the ongoing war in Ukraine, rising interest rates, and global supply chain difficulties. This resulted in a decrease in the number of deals and a reduced average deal value. However, most PE funds still share a broadly positive outlook for the remainder of the year. Opportunities may arise from corporate groups divesting non-core assets, an increase in distressed assets, and limited partners pressuring general partners to hasten exits. PE buyers are focusing on due diligence and creative solutions to bridge valuation gaps. Access to debt financing has become more difficult, leading some funds to acquire minority stakes with the potential to acquire a majority stake later. Environmental, social, and governance factors and digitalization are expected to play increasingly important roles in the industry. Despite challenges, the European PE industry's resilience and flexibility position it well to capitalize on future opportunities.
Source: Financier Worldwide
Leveraged credit markets tap the brakes; private credit looks even further afield
The European leveraged loan market experienced a setback when Restaurant Brands Iberia pulled a proposed €310 million loan repricing due to sinking trading market prices and global concerns. The US loan segment faces headwinds as retail investors have withdrawn $1.1 billion from leveraged loan mutual funds and ETFs, resulting in a net outflow of nearly $15 billion year-to-date. New-issue market activity has slowed, with only $1.9 billion of institutional deals this week, down from $6 billion last week. LBO deals have been scarce, and Moody's predicts they may not return in a significant way until 2025. The private credit sector remains eager for deals, with ACME Credit Partners entering the space, focusing on opportunistic investment strategies. Retail investors have also withdrawn $6.7 billion from the fixed-rate high-yield bond segment over the past three weeks.
Artificial Intelligence Scope/ Trends
Three ways AI is changing the private equity game
AI is changing the private equity landscape by providing significant return on investment in three areas: deal flow, investment pre-screening, and risk intelligence. This helps PE firms act earlier than their competitors, which is crucial in the private equity game. AI technologies like natural language processing (NLP) and generative AI help overcome information overload and process vast amounts of data into actionable insights. In deal sourcing, AI helps analysts sift through information and identify opportunities faster. In pre-screening, AI assists in the initial due diligence phase, enabling quicker decision-making. In risk intelligence, AI helps monitor potential controversies and risks, allowing firms to take corrective actions in time. To effectively use AI in private equity, firms should define their use cases, objectives, and metrics, empower their teams with AI tools, put the right AI leadership in place, and address AI's flaws and risks head-on.
How private equity scores on sustainability
The conversation around sustainability in private markets has intensified, with critics accusing the industry of greenwashing and prioritizing sustainability over financial returns. BCG's first annual "Sustainability in Private Equity" report aims to provide a clearer picture of the industry's performance on social, energy, and sustainability metrics. The report is based on data from the ESG Data Convergence Initiative (EDCI), a coalition of 350 major private equity general partners and limited partners. With over 62,000 data points collected from around 4,300 PE-backed companies, the report shows mixed performance on sustainability topics compared to public markets. However, there is evidence of effective links between sustainability performance and financial outcomes. The PE investment model can improve sustainability outcomes, and this year's EDCI results support this view. As the global economy transitions to become more sustainable and inclusive, PE investors have a unique opportunity to deliver sustainability performance gains that drive positive business outcomes.
Emerging economies need much more private financing for climate transition
The transition to net-zero emissions by 2050 requires significant climate mitigation investment in emerging market and developing economies, which currently emit around two-thirds of greenhouse gases. These countries need about $2 trillion annually by 2030, a fivefold increase from the current $400 billion of planned climate investments. The private sector must contribute around 80% of the required investment, rising to 90% when excluding China. Attracting international investors is challenging due to underdeveloped financial markets and lack of investment-grade credit ratings. Phasing out coal power plants and aligning climate policies with net-zero targets are major challenges. A broad mix of policies, including carbon pricing, structural policies, and innovative financing solutions, is needed to create an attractive investment environment. Policies should focus on creating climate impact and consider the specific needs of emerging market and developing economies. Public-private risk sharing and multilateral development banks can play a crucial role in fostering climate investments.
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