With widespread COVID-19 vaccination now on the horizon, the global pandemic appears to be approaching a turning point — and we all may be entering a prolonged period of very low interest rates along with it. How can private equity (PE) firms adjust their strategies accordingly?
Recent surveys suggest an ambivalent answer:
- PE firms are setting their sights on select investments and other potentially high-growth opportunities in the very near-term future. They're still sitting on powder kegs of dry powder, after all.
- However, in the context of ongoing market volatility, and with no sign that regional and market variations are going away anytime soon, just how exactly these firms should deploy it to maximize their returns is anyone's guess.
With that in mind, let's dig into the state of PE today, then turn to where things appear to be going next.
setting the stage: top PE priorities in 2021
What has been the net impact of COVID-19 on PE so far? How is that in turn affecting the outlook of PE managers — and the actions they'll likely pursue next?
As to the first, there's general consensus emerging. According to a recent survey of PE leadership conducted by Harvard Business Review, most PE managers believe that something like 40 percent of their portfolio companies have been moderately negatively impacted by COVID-19, while another 10 percent have been very negatively impacted by the pandemic.
Without minimizing the scale or scope of that disruption, it's worth pointing out that the flip side of such a forecast is pretty good. That is to say, it means that the majority of PE portfolio companies — a small majority at 50.9 percent, to be sure, but the majority nonetheless — have managed to brave the pandemic with little or no negative impact, according to the same survey.
That's a crucial fact to bear in mind. After all, the relative financial health of portfolio companies is going to be the number-one factor in determining the actions taken by PE firms going forward.
For the 10 percent of portfolio companies that have been "very negatively" affected by the pandemic, bold action very well may be in order. Reducing headcount, introducing cost-control and -containment measures, overhauling budgeting and planned expenditures — all of these options (and more) will be on the table. In some cases, replacing management may be viewed as an attractive option as well.
Yet even for these companies, things could be worse. According to another recent survey, four out of five PE managers say their firms do have enough liquidity to support their portfolio companies in the coming months, if needed. So that alone should be grounds for optimism.
Meanwhile, for companies that have been far less severely affected — companies which, again, collectively represent about 90 percent of portfolio companies on the whole — expect PE firms to deploy much more moderate strategies. Think: the usual mix of operational and strategic guidance. Efforts to increase value by adding new members to the board will likely be ongoing as well.
PE performance: understanding what comes next
In line with the forecast for overall impact on PE portfolio companies, leaders in the space appear to be gearing up for a renewed period of action. According to one recent survey, for example, more than a quarter of PE leaders — 27 percent — think investment activity could actually increase in the coming months. That's far more optimism than you'll see in many other sectors today.
Across the board, too, capitalizing on new investment opportunities — as opposed to, say, shoring up flagging portfolio companies — appears to be very much top of mind. Take the following findings from the same survey:
- Well over half (58.5%) of PE managers say that they're looking to make selective new investments right now.
- Only about one in five PE managers (22%), by comparison, say that their primary goal in the near term is addressing the immediate needs of their portfolio companies.
Clearly, then, the stage seems to be set for growth, and that's true — to a surprisingly homogenous degree — globally as well. For example, you might expect bullishness out of China and East Asia, where the pandemic first hit and recovery efforts are more advanced than in most of the West. Yet evidence of similar optimism is being reported elsewhere, too. Take Mexico, for example. The country's M&A deal value slipped by more than 25 percent in 2020 compared to 2019, and yet the forecast is for a strong rebound in 2021.
All of which is great news. It's also grounds for thinking that PE leaders have a busy season ahead.
key takeaways
For now, while PE firms continue to operate in a state of flux, there are very real signs of a preliminary, cautious optimism emerging. Perhaps more fundamentally, the present moment calls attention to some salient difference between the recession of 2008 and our current global pandemic. Namely, most of the major players in the PE space eased their feet off the gas back then, halting their investments for a number of months (or in some cases, even years). Today, that definitely does not appear to be the case.
It may also be worth reflecting on all of the different ways that navigating in this new normal presents not only challenges, but also opportunities for PE leadership. Incorporating a higher-than-average level of flexibility into strategic planning will be key to success. Unfortunately, as anyone who's been at the helm of a fund during periods of persistent volatility will attest, that's a whole lot easier said than done. Time will tell.
If your firm is looking for experienced PE leaders to help navigate the tides of change, get in touch with Tatum below to find out why we're the strategic partners that leaders in your field trust.