Private equity has lots of money at the ready—the question is, what will it be used for?
In the months ahead, a decline in prices across the market means investors will be looking at an unprecedented opportunity to buy. On the other hand, they will be trying to keep their current crop of companies healthy. Firms will benefit from the stockpile of capital the industry has accumulated, but they will also be hamstrung by a lack of reliable information until the dust settles. And no one knows precisely when that will happen.
PE firms don’t operate in a vacuum, especially in a fast-moving scenario like this one. They’ll need to work hand-in-hand with lenders (and perhaps their limited partners) if the next few months are to go smoothly.
Many portfolio companies will inevitably be in pain this year, and hundreds will need help from their PE sponsors. First, firms will urge their portfolio companies to tap lines of credit. Other situations will require capital infusions from the PE sponsors themselves. Investors will avoid such scenarios if they can, but if they can’t, they’ll have to earmark a portion of their dry powder for existing investments in the form of recapitalizations or unplanned growth rounds to refurbish balance sheets. More coronavirus news: Continuing coverage from PitchBook.
Making capital calls to limited partners brings its own set of headaches. Like pensions and sovereign wealth funds, LPs are tending to their own crises and might not pick up the phone right away. Concerns are forming that LPs will slow-walk their capital calls, especially if those calls mean they have to sell other positions at deep discounts just to come up with the money. Similar concerns were voiced during the financial crisis, but to their credit, most LPs stepped up to the plate last time. Bear in mind that other asset classes are banking on the same thing, including venture capital and real estate. Pension administrators will be exceptionally busy from this point forward.
As outlined in PitchBook’s recent analyst note on the COVID-19 outbreak, we think well-funded PE vehicles will be forced to inject liquidity into existing portfolio companies and ultimately reduce the leverage that provides the enhanced returns LPs are looking for. We also think firms will be forced to underwrite deals to lower return profiles, which might remove a significant portion of viable target companies overnight.
On the other hand
PE-backed companies aren’t the only ones that can use a quick capital infusion. Opportunistic buyouts of other such cash-strapped businesses can be lucrative for investors, but they can also represent a financial lifeline to unsponsored companies that may otherwise go under. Thousands of employees could benefit as well.
However, those scenarios require the backing of lenders. Some lenders are blanching and hoisting up the gate; others are still taking calls. Private debt dry powder was sitting north of $240 billion as of the start of Q2 2019, according to PitchBook’s H2 2019 Global Private Debt Report, and we see direct lenders investing through a downturn alongside the PE funds that will pivot toward opportunistic sourcing in the public equity markets and distressed situations.
Activist hedge funds may be an X factor, as public equity stakes have become relatively cheap to accumulate. As we’ve seen with more regularity in recent years, activists are acquiring toeholds and pushing for management changes—sometimes followed shortly by private equity takeover offers. The lines between public and private equities have already become blurred, with PE funds holding stakes in public companies and hedge funds raising dedicated private market vehicles. We’ll likely see a confluence of actors bearing down on the public markets to take advantage of the unprecedented opportunity.
PE firms are now dusting off the records of companies they’ve passed on recently. The diligence is already done—in many cases the prices were too high at the time. That’s no longer the case, and phone calls can be made and companies financed rather quickly. But they’ll need to convince lenders to come along and get their LPs on the phone before anything happens.
Private equity’s supporting actors are all wondering where the bottom is. Any reticence on their part will dictate what happens over the next few quarters.
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