No need to panic about high dry powder as PE market comes roaring back, says Bain

Although Q2 2020 saw a global slump in deal-doing as coronavirus lockdowns took hold, a Q4 surge in deals meant that the market remained resilient. The same pattern was also seen with exits.

"The resilience of the market has been remarkable and the number of write-offs has been relatively low," says de Vusser, noting that a wave of distressed investments or insolvencies does not appear to have materialised. "There was a lot of activity from credit funds in Q2, but the credit market also rebounded quickly, which closed the window of opportunity in the short-term. The support of the governments shows that there is a clear plan to support the economy throughout the crisis. There will still be opportunities for distressed investments in specific sectors, but we believe that 2021 will be quite healthy and will prove the resilience of the market, as we saw in the GFC. The funds that invested in the midst of the crisis will also outperform."

The report also finds that valuations remained high in 2020, with average multiples of 11.4x EBITDA in the US and 12.6x in Europe. Technology buyouts comprised 29% of global buyouts by volume, rising to 32% if the fintech sector is also included. Bain & Company expects that there will continue to be keen interest in this sector, as well as other non-cyclical sectors, reflecting a shift to more durable sectors that began even before the pandemic hit in anticipation of a potential downturn.

Dry powder now stands at around $3trn globally, according to the report. "The increase in the absolute amount of dry powder is a question that has come up every year for the last 10 years," says de Vusser. "The growth in dry powder is a driver of the success of the market as a whole; more funds are being raised, so the market is growing. Looking at the age of the dry powder, we see nothing alarming. It's at levels that are similar to the past – it might be a little higher as we are coming out of a Covid-19 year, but the average age is 22 months, which is lower than it was at the back of the last financial crisis." The average age of dry powder going into the GFC in 2008 was 20 months, rising to 27 months in 2009 and 35 months in 2010.

Keeping track of performance
Global fundraising amounted to $989bn in 2020, compared with $1.09trn in 2019, which was an all-time record. In spite of the pandemic, 2020 still saw the third highest total ever recorded. Comparing the average amount raised for different strategies from 2015-2019, secondaries vehicles raised 170% more on average in 2020, while growth fundraising was down by 41%. Buyout fundraising remained unchanged on average compared with the previous five years.

The report notes that 84% of the funds that closed in 2020 did so above their target amount. Funds at the larger end of the market had an easier time on average, with funds seeking $5bn or more in assets generally closing within six months and 18% above their initial target. Specialised funds of all sizes also managed to raise as quickly and often above target. However, first-time funds took 14 months to close on average in 2020, with 88% meeting their target and 6% exceeding target. Larger, experienced funds took six months on average, 100% met their target and 18% closed above their target. Smaller experienced funds also took 14 months, with 83% reaching their target and 14% exceeding it.

Every European mid-market fund that is generalist should rethink its strategy and ask what the route is that it will take in differentiation" - Christophe de Vusser, Bain & Company

While an unstable market could damage returns for GPs, fears about this also do not appear to have materialised overall, the report finds. 10-year annualised IRR figures processed for the report show that funds have so far not been damaged to the extent they were in the GFC – this applies to both the bottom quartile and top quartile of performance. PE also continued to outperform public markets in Europe, although the gap between the two narrowed somewhat in the US, with public market returns increasing.

The report also compares average MOIC figures from 2005-2020 and finds that the average return netted by this measure in the period was 2.19x. The average for 2019 was 2.6x, compared with 2.3x in 2020. Sector analysis showed that technology deals saw a 27% increase on average between 2000-2008 and 2009-2020. Business services deals saw a 24% MOIC increase on average in the same period, while returns for consumer deals declined by 28%. However, the report notes that even resilient sectors can see a broad spread of MOIC returns; technology returns range from an average of 2x in the bottom quartile to up to 4x in the top quartile.

Specialisation and differentiation
High multiples and fierce competition will remain driving factors in the months and years to come, Bain argues, meaning that specialisation and differentiation will be even more vital for sponsors. "As sector specialisation and thematic investment become increasingly important, with multiples rising, this places challenges on the non-specialised mid-market funds," says de Vusser. "There is a split in the market. There are the scale platforms that, due to their scale and product offer, are sitting on expertise and can build specialisation within their scale. Then you have the infra funds, growth funds etc. So, the issue for generalist mid-market funds in Europe is how to differentiate when they are fighting against sector specialists. Every European mid-market fund that is generalist should rethink its strategy and ask what the route is that it will take in differentiation."

The report also includes in-depth studies of market trends emerging from 2020. ESG as a means of value creation and differentiation, and not just as a set of criteria to be fulfilled, was increasingly important in 2020. "This year was the year ESG became real in Europe," says de Vusser. "People already knew that they should be compliant and might have thought about raising an impact fund. But what we have seen happening at the European level this year is that ESG is becoming core to the buyouts. Sponsors are seeing that they can become an ESG leader in their industries. If you can prove to consumers that your operations and products are better from an ESG point of view, you will win more customers, and the exit multiple will be higher, so people are seeing that you can make better returns. You can win market share, have a better cost structure, and a better financing structure. Sponsors don't need a separate impact fund – they need to use ESG to drive deals in all sectors."

In spite of the challenges faced by the PE industry when it comes to digitalisation, specialisation and tough competition, the market is expected to remain dynamic and resilient. Says de Vusser: "Overall we believe this year will be a great year for PE in all dimensions. Looking at 2021 data through February, global buyout deal value is 60% higher than the average of the first two months for the past five years. Public markets are still healthy, which is important. And the split between exits via IPOs in public markets and secondary buyouts was healthy in 2020."

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