Private equity’s horrible, no-good ’23 set to continue into ’24
FOR private equity (PE), 2023 turned out to be a terrible, horrible, no good, very bad year, and the pain won’t likely end until it’s clear that central banks have truly decided to stop hiking rates. US PE firms bought or sold US$871 billion in assets last year, the lowest level since 2016, according to data provider PitchBook. And the projected rate of distributions to private equity investors was the second-smallest in a quarter century, investment bank Raymond James said.
PE firms have been grappling with higher borrowing costs, economic uncertainty and sluggish fundraising. And as they have been slow to return capital to pension funds and other key investors, once-reliable clients are maxed out on the cash they’re willing to allocate to such investments.
“It’s going to be a slog,” said Andrea Auerbach, head of global private investments at Cambridge Associates. Firms must “work on their portfolios to create assets that can be sold profitably”.
Signs of a thaw
The value of initial public offerings fell almost 60 per cent in 2023 from their peak two years ago, according to research house Dealogic. While there are some signs of a thaw in PE activity, Blackstone president Jon Gray said that any economic slowdown in the first half of the year could further snarl deal flow by boosting volatility. The real catalyst for any turnaround will be an assurance that the Fed is done raising rates. “What you need for transactions is confidence,” Gray noted at a December financial conference. “You need terra firma.”
PE firms that can’t demonstrate that key funds have paid out more to clients than what was invested will fall out of favour. That metric is “a mark in the sand for investors”, said Sunaina Sinha Haldea, global head of private capital advisory at Raymond James.
Managers with older funds that still haven’t hit that mark will have a harder time finding backers the next time they want to raise money, forcing them to offer discounts on fees.
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Financial engineering
Many firms are likely to resort to financial engineering such as borrowing against their investment funds to increase the cash they need to buy more assets or return capital to investors. Some will shuffle existing assets into new funds, effectively kicking the can down the road to avoid selling a company for less than they paid. But some investors oppose such transactions because there’s a potential conflict of interest when buyer and seller are the same firm.
In spite of the turmoil at PE firms, investors are sitting on record amounts of cash.
Samer Ghaddar, deputy chief investment officer at the Arizona State Retirement System, felt that this augurs increased dealmaking in 2024. And lenders are increasingly interested in private equity transactions, particularly less risky purchases requiring relatively low levels of debt. “Banks are getting more comfortable financing larger buyout deals,” he added.
But don’t expect PE firms to cash out of investments they made in the easy-money era anytime soon, said Brenda Rainey, a partner at consultant Bain & Co. “The industry,” she noted, “is a snake digesting an elephant that they swallowed in peak dealmaking years.”
Since many of those deals are only a couple of years old and the funds typically run for a decade, the firms can wait for better times – or at least until investors lose patience. BLOOMBERG
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