Private equity firms getting back to M&A business

While far from pre-pandemic levels, the private equity market across the globe is poised for a rebound as general partners start scouring the market for deals. This is according to a new Bain & Company analysis.

The firm points to a notable spike in deal activity in June when compared to the thick of the crisis, marking the first steps in the right direction. The trend is visible across the world, barring Asia-Pacific, where deal activity remained at a steadily high average due to variations in the spread of infection and economic repercussions.

No doubt, deal activity is far from pre-pandemic levels, given that the overall deal count for the first half of this year fell dramatically by around 35% across the Americas as well as in Europe, Middle East and Africa (EMEA). That being said, Bain suggests that there are promising indicators of a steady uptick in activity over coming months.

Hugh MacArthur, author of the report and partner at Bain’s Boston office, says the consulting firm is in a unique position to foresee deal volume across the globe. “As the largest provider of due diligence to private equity firms worldwide, Bain’s diligence work can be seen as a leading indicator for deal-making globally,” he wrote.

And due diligence activity has certainly spiked in June when compared to the period between March and May. The outlook is promising, and marks a distinct shift from the aftermath of the last recession – the Global Financial Crisis of 2008. MacArthur highlights several reasons for this. 

For one, capital reserves in the private equity sector currently amount to $2.6 trillion, which is twice the amount that was available immediately prior to the last crisis. General partners will be looking to put these funds into growth instruments at the earliest possible date, which offers some explanation for the rushed return of deal activity.

The desire to put this money to use brings us to the second reason for a quick rebound – the significant opportunity presented by distressed assets during the crisis. “As the industry learned after the last recession, smart investments made near the bottom of the cycle tend to produce above-average returns if you move decisively,” wrote MacArthur. While most high-value distressed assets have presumably been acquired by this point, the general trend has put the equity markets in a broadly health position.

Underlying both these reasons is the fact that this crisis is simply different from the GFC. The 2008 crisis represented a failure of the global financial system, whereas the current crisis came from natural causes and is no reflection of financial health whatsoever. As a result, while demand has taken a big hit during the crisis, there is an expectation that it remains fundamentally strong.

All these factors have combined to breed investor confidence, most visibly evident from the sentiment among limited partners (LPs). Bain’s report highlights a Campbell Lutyens survey from April this year, when nearly a quarter of all LPs had commitments on hold, while only a third were in a “business as usual” scenario.

Not surprisingly, year-on-year capital raised fell by 18% across the globe in the second quarter this year. However, there was a dramatic shift in LP sentiment come June, when nearly 60% had moved back to business as usual, and only 8% had projects on hold. Bain attributes this to a mixture of factors, including: resurgent equity markets and the consequent scope for balanced portfolios among LPs; reduced liquidity concerns; and a more long-term commitment to assets.

So things are looking up for the global private equity market. At the same time, many investors remain unsure of how to react to the current market conditions. For instance, there is always the concern that the current subdued levels of demand may persist in the near future. Against this backdrop, accurate valuation is a near impossible challenge.

MacArthur suggests that LPs will be ever more selective in their approach to financing, with highly optimized businesses coming up on top. Three considerations are likely to play a part going forth. First, sector-specific expertise is worth its weight in gold at the moment. Investors will have to look beyond financial analysis to see how each sector has fared during the crisis, and where they are likely to head in the near future.

“To invest with confidence, firms will need a sophisticated understanding of what customers value, how the industry needs to pivot, and how management can deliver new kinds of services in the highest-quality way. For a generalist, those insights are hard to come by,” he said.

Secondly, investors will have to reassess their value creation models. Under dynamic market conditions, traditional value areas will be shifting constantly, and adapting quickly will be crucial. Take for instance the sudden demand for online groceries: immediate investments in digital delivery channels have been crucial to ensuring that margins remain in place.

Leading from this, the last consideration is digitalization of the private equity world itself. Investors have realized that travelling hundreds of miles for a meeting is no longer necessary, when a simple Zoom, Skype, or Teams meeting will suffice. Even in investment decisions, tech has a huge role to play.

“Increasingly, firms are using data, artificial intelligence, machine learning, and automation to find companies, conduct due diligence, underwrite risk more comfortably, and do it faster. Firms that aren’t moving in this direction risk being left behind,” said MacArthur.