Worldwide: Private Equity – At A Turning Point

The buy-out market was rather subdued throughout 2023, with global private equity (PE) deal volume down by 22% year-on-year, according to Mergermarket.

This is due, most notably, to uncertainty in the pricing of debt, given steep global monetary tightening since the Covid pandemic. It also reflects more general economic concerns, such as the resurgence of inflation or possible recession (both of which appear to have subsided).

These factors have resulted in a continuing and fundamental mismatch in sell-side and buy-side expectations amongst both PE firms and strategic acquirers. PE firms have however remained busy on fundraising and portfolio management, including bolt-on acquisitions and restructuring assets. They have also amended and extended debt, indicating that financing is still available for strong credits.

As the rates environment stabilises (and absent any new major disruptive macro events), many PE firms enter 2024 in good shape to take advantage of an expected increase in activity, with strong support from lenders. This is supported by indications we have had that many PE firms expect a busy first half of 2024.

2023 – macro-economic factors dominate

Leverage

Patchy availability of leverage, and significant uncertainty around its pricing, is the main factor behind the relative lack of buy-out activity. This has resulted in buy-side PE firms coming to significantly different valuations for acquisition targets than those acting on the sell-side.

By way of example, UK leveraged loans in the liquid market were priced around 4.00% (above a 0.25% Bank of England (BOE) base rate) in early-2022. In contrast, by the middle of 2023, the UK liquid leveraged loans market was closed, and the only practical option available to PE firms for acquisition financing was through private credit – traditionally a more expensive option due to associated higher risk levels than private credit funds are willing to take. Such private credit deals were typically priced around 6.75% (above, by Sept 2023, a 5.25% BOE base rate) with tighter terms.

Wider factors

More generally, PE buyers have struggled to have confidence in wider global economic performance. At the start of 2023 it looked likely that many developed countries would suffer some kind of economic recession as interest rates rose. This did not happen, but nor has there been a significant economic upturn in any major economy outside of the US.

The mood was not improved by the fact that many sellers (including PE sellers) will have looked back on the levels of pricing they achieved in the scramble of 2021-2022 and may have held out a little too hard for these to return last year. This goes a long way to explaining why the pipeline for auctions expected to be launched during Q1 2024 for the sale of assets by PE has notably increased compared to the beginning of 2023, as valuation expectations have softened.

Pockets of activity

By contrast, the Spanish PE market has managed to navigate the economic uncertainty thanks to some good quality assets being available in the market and seller flexibility as regards valuation and deal structuring. We have seen more price deferrals accepted by sellers, higher equity fundings taken by PE, followed by a syndication of that equity with limited partners (LPs), and significant roll-overs by sellers, allowing buyers to rely on that reinvestment from a business risk perspective.

In Germany we have seen activity in traditional sectors (eg, the acquisition of Lufthansa's international catering business LSG by Aurelius) but notably also in the digital space and the energy and infrastructure sectors, in anticipation of the much-needed Energiewende (energy transition). Further transactions in these sectors are either under way or expected to kick off early in 2024 so the outlook has improved in comparison to 2023.

In France, the mid-cap market played its cards better than the large-cap market over 2023, in particular thanks to an increasing number of regional transactions outside of the Paris area. We have also seen some resilient sectors like healthcare, education and energy/infrastructure driving the PE market.

In Australia, we have seen a much higher proportion of deals being done on a bilateral basis with detailed term sheets and exclusivity to create greater certainty and reduce risk of failed deals and abort costs.

Portfolio management and restructuring

The generally subdued buy-out market has allowed PE investors to focus on fundraising and the important tasks of portfolio company improvement, bolt-on acquisitions and, where necessary, restructuring. In London, we have been busy helping our clients expand their existing platforms, most notably in the technology and residential management sectors, as well as restructurings in areas such as fintech.

Outlook for 2024 – A turning point

Parochial market factors becoming increasingly important

The macro-economic headwinds of 2023 are receding or becoming less important to PE investors' thinking.

Global central bank interest rates now seem to have found a level and may even trend downwards throughout 2024. As buyers have an increasingly clear view on what debt is likely to cost in the medium term, they will be able to price assets accordingly.

Drivers of acquisitions and sales

Many funds have amassed investor commitments since the start of the Covid pandemic. These are now well into their typically five-year investment period. If funds want to spend them, then they will need to do so soon.

PE buyers returning to the market will be welcome news to sellers of all types, including PE sellers. With buyers in short supply and subdued equity capital markets making IPO exits challenging, many sellers have struggled to sell even good companies, for which they will want to find a home in 2024. Any PE firms making a serious attempt at raising new funds in 2024 will be especially keen to show a track record of returns to their existing investors.

Secondaries

This unblocking of the market could herald the return of secondary buy-outs (sales from one PE firm to another) in a meaningful way in 2024.

An increasing trend in recent years has been general partner (GP)-led secondaries, under which two funds managed by the same firm trade portfolio companies. This can constitute an attractive exit route for relatively old funds but will be dependent on the availability of (generally newer) funds willing to buy. With LPs generally keen to take liquidity where they can get it, LPs' appetite to rollover their commitments to continuation vehicles has been limited.

There is unlikely to be a sudden opening of any buy-out window. Rather the process of life returning to the market will gradually take shape over a number of months, even amid growing indications that it may already be underway. There is also the question of whether we will see the return of the dual-track or sponsor-backed IPO for larger assets where the LBO market is constrained, resulting in valuations not achieving their target.

Setting aside questions of exact timing, we expect 2024 will be marked by a significant, and positive, evolution in PE as a productive and sustainable asset class.

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