United States: How Private Equity Managers Are Reassessing Their Exit Strategies

Faced by a slump in PE exits, progressive managers have shifted focus to driving tech enablement and building sector expertise. As Onno Bouwmeister, Vistra Global Sector Head of Private Equity, explains here, being at the forefront of such change may be the way to ride out the current economic storm.

Private equity exits have been adversely affected by the global Covid-19 pandemic. Recent research suggests that in May, with the world economy in lockdown, exits slumped almost 70% year-on-year. Meanwhile, more than 80% of PE groups responding to an Investec survey said they would retain their holdings for another year.

These are cross-sector figures. In harder-hit areas, such as hospitality, bricks-and-mortar retail and commercial real estate, the hiatus in PE exit activity is even more pronounced.

It's important to clarify, however, that not all companies are in the same position. The pandemic has driven considerable value in some areas of the economy – healthcare, e-commerce and technology enablement, for instance. In these sectors, some GPs have even decided to reinvest.

This is perhaps unsurprising considering that at 30 June, healthcare was one of only three sectors to post positive year-to-date returns – (+1.3% compared to -5.8% for the MSCI World index - source) .

There are also few signs of forced exits. Research conducted by Willis Towers Watson suggests that the significant turmoil in capital markets has had little effect on the capital structures of portfolio companies, with 87% of respondents indicating that their holdings were unlikely to breach covenants as a result.

This doesn't mean that there hasn't been any action. One notable exit during the second quarter of 2020 was tech company ZoomInfo. The company raised nearly $1bn in its IPO, with its value nearly doubling in price on the opening day, putting its market cap at around $15bn.

TA Associates paid $90 million for its stake in ZoomInfo in 2014. That stake is now worth more than $6.2bn, the largest paper gain in the firm's history. The Carlyle Group also achieved a significant return, collecting 13 times its investment in little more than a year.

Despite these specific instances, PE managers still face an unprecedented economic and financial landscape. So, what should be at the top of their 'to do' list right now, and how should they tailor their exit strategies to ensure they can thrive in the new 'Covid economy' in the months and years to come?

Reassessing exits and the role of technology

The GPs that Vistra speaks to are saying they're deferring exit for two main reasons – huge uncertainty around what the 'new normal' will look like and the need to recover value lost as a result of the pandemic.

For those wishing to tread cautiously during uncertain times, deferment offers the perfect opportunity to reinforce and strengthen the health of their holdings in the hope that the markets adjust and settle. For PE managers who have seen portfolio companies lose value, however, now is the time to reassess and potentially reinvent their exit strategy in a bid to make up lost ground.

In both instances, managers can't rely on their initial pre-Covid plan to build value into their businesses. They must re-evaluate the value-creation plans they put on the table at acquisition. Are these plans still applicable in the current environment? If not, they will need to build in new scenarios that lead to exit.

One of these scenarios will involve fast-tracking technology enablement, digitisation and automation. This drive for digital transformation is one tactic many GPs will justifiably rely upon when recouping and strengthening portfolio value. Covid-19 hasn't necessarily created any new trends, but it has definitely accelerated the need for tech transformation.

During PE managers' due diligence, they will need to look at the way their portfolio companies did (or continue to do) business during the pandemic and then guide them from an analogue environment to a digital one.

US PE firm The Carlyle Group are already showing signs of such behaviour. It acquired Boston Consulting Group two years ago to help it determine how best to use digital innovation to drive value in its portfolio companies.

One particularly interesting example of tech enablement was with market research company Claritas, which Carlyle had previously acquired in 2017. The strategy subsequently implemented aimed to pivot from outdated marketing techniques to digital marketing. Claritas acquired three companies in three years to bring this plan to fruition – showing digital transformation need not be organic.

As a result of those acquisitions, the Claritas $1bn market research addressable market was transformed into a $25bn digital marketing addressable market, adding great value to the company.

The stark reality is that those managers who didn't have a plan to fast-track technology enablement pre-Covid, will be playing catch up post-pandemic. Digitisation is essential for portfolio companies' future health and is a critical way to add value while exits are delayed.

Managers are in a good position if they can prove that a conventional business is tech enabled. And they may not necessarily need to prove that the job is totally complete. They may even want to leave some value on the table for the next investor. In the current climate, and with exits deferred for a limited period, the speed to deliver on tech enablement is a critical element.

Rebalancing portfolios based on sector expertise

Another major trend we have noticed at Vistra is the growing demand for sector expertise among PE managers. Granular sector knowledge is increasingly being seen as vital in order to create value for portfolio companies as a result of the pandemic.

For diversified managers with investments in a wide range of industries, each with different dynamics, it may prove difficult to understand the specific challenges individual portfolio companies face in the current environment.

Pre-Covid, managers may have invested in highly diversified industries such as retail, technology and heavy industry. Now, however, we think it's likely that small to medium-sized equity firms will rebalance their portfolios. They're going to be more selective with their private equity strategies, focusing on and developing greater expertise within specific sectors.

That said, large private equity firms, with sufficient levels of finance and enviable resources, can more easily build silos and sub-categories within their organisations to create that in-depth expertise and develop a more diversified buyout portfolio.

The reality is that the private equity sector is guaranteed a period of uncertainty while the markets make sense of the pandemic and adjust to an as-yet-undefined 'new normal'. Ultimately, however, those markets will bounce back and we are likely to see a flurry of exits during the latter part of 2020 and into next year.

This will be driven by nearly $2.6trn-worth of dry powder in the sector, which is currently waiting to be invested. Based on what we saw after the global financial crisis, now is a good time to acquire, because valuations and returns are optimised in this kind of environment.

PE managers who invest in tech enablement and further professionalise their operations by developing sector expertise will be in the best possible position to capitalise on that bounce-back. Indeed, not only will these strategies see them recover from the impacts of the pandemic, they will help build solid foundations for future success.

Originally published by Vistra, August 2020

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