Source: Hedge Think
The idyllic vision of a “V-shaped recovery” may have let economies down – but not Private Equity. As if the industry’s triumphant rebound of 2020 wasn’t enough, many expect the upward stroke of its ‘V’ to be extrapolated into 2021. From dry powder to ESG, what trends shape the industry in the coming year, and why the bullish outlook?
As the pandemic materialised in the earlier months of 2020, Private Equity appeared vulnerable as did everything else. According to Pitchbook, Private Equity transactions in the US fell nearly 20% in deal value hitting a low of $326.7 billion by the end of Q2 2020. Exits were down by 70%.
The latter half of 2020 tells a completely different story. As the winners and losers from the shock became apparent, private markets, and especially private equity, came to side with the luckier bunch. Value of deals soared to highest levels since 2007, ending the year with $559 billion worth of deals worldwide. 2020 drew to a close with multiple high-profile, landmark transactions such as Apollo’s $1.9 billion take-private of Toronto-listed Great Canadian Gaming Corp.
On the surface of things, this rebound in deal activity accrues to a “backlog,” i.e. a get-going of deals that have abruptly halted in previous months. But with a closer look, the upswing is far from momentary. Private Equity funds are backed by historical levels of dry powder (a term for unspent capital); it is estimated that in the US alone, there is $1.7 trillion at the sector’s disposal. With so much capital, investors are most likely to up their spending game in 2021. We expect sustained strength in certain sectors like TMT, Pharma, Biotech and Industrials that delivered some of the most valuable deals in 2020. Diversification into wider asset classes like private debt, real estate, infrastructure and ESG will continue (– the last thing investors want, in times like these, is to put their eggs all in one basket.) APAC’s rapid growth is also on the watch. Their PE/VC dry powder market share now represents 25% of the global total, and is expected to outgrow the US and EMEA in 2021.
Ultra-low interest rates make Private Equity more attractive (than, perhaps, fixed income and credit securities that rely more heavily on market rates) to pension funds, insurers and the like. At the same time, it makes cheap funds accessible and the resulting competition for assets drive up valuations massively. In a world were central banks are locking themselves into near-zero rates for god-knows-how-long, easy capital seems to be a given in 2021. Read more on the ballooning valuations and the ‘Rise and Rise’ of Private Equity here.
We anticipate healthier exit markets going into 2021. Private Equity-backed IPOs are trendy: which seems almost natural given the broader boom across the general IPO market. According to Pitchbook, Private Equity firms have logged $74.5 billion in exit value across 22 IPOs which is a significant rise in value/deal (see graph). A notable IPO in due course is Bumble, backed by Blackstone: the billion dollar dating app is set to go public around Valentine’s day. (Investors love sweet rumours like these.)
Another trend to look out for is the growing popularity of ‘Continuation Funds’ – a fancy term for when a Private Equity firm sells off a portfolio company to another fund of its own. The logic is simple. When investors have had their money locked up in a single fund for around a decade, they demand returns. Yet the 10-year cutoff period doesn’t mean the company grows by itself – in many cases, it may need a few more years to deliver satisfactory returns upon a transaction. Plus if anything, COVID has made exits harder than ever; against this backdrop, it is understandable how firms are increasingly adopting this unorthodox “exit” strategy. At the end of the day, a Continuation Vehicle 'buys time' – whether that be to obtain fresh capital for further investments, help struggling subsets of the portfolio, or simply wait for the upside yet to come. Blackstone, EQT, BC Partners and Hellman & Friedman are among a few who have already sold (or are in the process of selling) from its left hand to its right. That being said, legal/tax issues which complicate things could potentially scare off some firms and investors. As the rollover process becomes clearer in terms of fees, governance, additional capital raising and so on, we expect many more deals like these in years to come.
The industry is set to face greater regulatory scrutiny in 2021 and beyond. This comes without surprise across the Atlantic as Democrats and progressive lawmakers take hold of Congress and the White House. Especially, Elizabeth Warren has been accusing the industry of debt-ridden deals that lead to layoffs and bankruptcies (a prime example being the woes of Toys-R-Us) since 2019. Not everyone agrees – why deter much-needed investment when economies are already struggling to their max? But this time, Republicans’ brakes may not be powerful enough as the Sen ramps up ‘Stop Wall Street Looting Act’ once more. In the UK, the government is also probing into how ‘carried interest’ – incentives received by General Partners – is taxed under capital gains rather than conventional income. Given current sentiments, it will be interesting to see if proposed reforms to close ‘regulatory loopholes’ gain further momentum in the Year Ahead.
Private Equity firms have grasped that ESG (Environmental, Social and Governance) is indeed the new black. Larry Fink (CEO of BlackRock)’s pledge to integrate 100% of the firm’s portfolios with ESG metrics captures just this. This shift in appetite for accountable investing is far from news; in fact, it’s a trend that's been gaining momentum for the past few years. Many, quite reasonably, thought the agenda would take a backseat as the pandemic hit. Yet the opposite proved to be true – investors sought long term, sustainable returns amid extra volatility, and net inflows into ESG funds based in the US hit a record high of $21 billion in the first half of 2020. What’s more, the heroic tales of those ‘sustainable’ funds that survived the stress-tests of COVID (and have delivered superb returns!) will act as catalysts for further growth. Because of the field's emerging nature, some challenges are yet to be addressed. Blurry ESG metrics, difficulty in mining relevant data, as well as inconsistencies in its assessment are all grey areas, rendering a ‘one-size-fits-all’ approach impossible. These setbacks, however, are unlikely to deter Private Equity firms from each adopting their own comprehensive ‘ESG screening processes’ in acquisition pipelines of '21.