The $3.2 trillion traffic jam in Private Equity
Value Creation Plan Newsletter #101
There are currently 28,000 unsold companies with a total value of $3.2 trillion, and it may be another two to three years before this money starts returning to investors. This is the bleak assessment of the traffic jam facing PE from recent reports by Bain Consulting, Pitchbook and Gain.pro.
The perfect storm
Higher interest rates, cost inflation, and geopolitical tensions have created a significant disconnect between company valuations and their actual tradability. Buyout deal activity has hit a 6-year low, down 32% from its peak. Half of the companies waiting to be sold are now at least 4 years into the investment cycle, a stark contrast to the golden days when PE funds operated on a 3-year horizon.
This decline in dealmaking activity is most noticeable in UK&I, DACH and Nordics, with 40-50% drops in volume vs 2021. On a more positive note, activity in Spain, Italy and France has only seen a 10% slowdown, possibly due to more attractive lower entry multiples.
The La-La Land traffic jam
For the companies that actually traded, exit multiples in 2023 were down 30% from the peak. The market is hesitant to pay top valuations, even for superior quality assets. According to MSCI, 70% of companies held for four years or longer are below a multiple on invested capital (MOIC) of 2.5x, with 36% of companies acquired 6 years ago or more now just breaking even.
As the exit environment remains sluggish, many PE Funds are still hoarding assets in funds nearing the end of their term life. Pitchbook estimates that 2017 vintage funds are approaching their maturity wall with up to 26% of their invested capital locked in assets, instead of being distributed to investors.
Furthermore, many buyouts are financed with term loans that reach maturity 6-7 years after the deal closes, meaning we are about to see an overhang of debt maturing and needing to be repriced for transactions made in 2016-18.
Don't panic!
Despite the headwinds and bleak outlook, there are reasons to be optimistic about PE as an asset class:
PE continues to outperform public markets over the long run. The 10-year IRR for buyouts in the US and Europe still exceeds the S&P500 and MSCI Europe indexes
The economy has so far avoided recession and inflation has moderated, meaning interest rate cuts are on the horizon, even if there is disagreement on when that will actually start to happen
There is $2.6 trillion in PE dry powder ready to be deployed once the traffic jam is cleared
GPs are buying time...
Structural tailwinds that propelled strong buyout fund performance over the past decade, particularly cheap leverage and multiple expansion, are unlikely to be as favourable going forward.
Getting liquidity back into the system will not happen over time. When the traffic starts to move again, it will be a multi-year process to work through the backlog of company sales. In the meantime, funds are using secondary sales, NAV loans (backed by their portfolios as a whole), or using continuation funds (moving assets from older to new funds) to provide partial exits and buy some time.
... but, at portfolio level, you can't just wait for the traffic jam to clear
Portfolio companies sitting in the traffic jam can't just let their assets languish. The urgency to sell this backlog of assets will become more pressing, and with it, the pressure to lower prices to complete transactions will increase.
Portfolio companies will need to show improved KPIs and position themselves in the best light in the crucial years before exit if they want to see good returns for all their hard work so far.
The urgency of now
If you thrive under pressure, now is a good time to be part of this industry. Lots of frantic activity is starting to happen across PE-backed companies in this environment, including:
Refreshing (or completely rewriting) the original value creation plan, as it has gone stale
Replacing C-suite talent halfway through the investment cycle, like a football team looking for fresh legs from the bench
Getting back to the basics of cashflow preservation, including renegotiating supplier terms
Getting the house in order now rather than wait for a buyer: lengthy ERP/CRM upgrades, complex post-merger integrations and messy customer data consolidations are back on the agenda
The above, plus a sprinkle of AI magic dust, will form the basis of a clear exit story backed with solid KPIs that you can show to future buyers.
Let's get ready to get out of the traffic jam,
Juan Lopez-Valcarcel
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Sources for data above are highly recommended reads:
Global view from Bain: https://www.bain.com/insights/topics/global-private-equity-report/
US view from Pitchbook: https://pitchbook.com/news/reports/q2-2024-quantitative-perspectives-under-pressure
European view from Gain.pro: https://www.gain.pro/investor-reports/the-state-of-european-private-equity-report
Image credit: Lionsgate, the La-La Land movie opening scene (pun intended)