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From slash-and-burn to grow-and-earn: private equity changes tack

  • Rachel Lewis
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Private equity has spent much of the last decade flying high on multiple expansion and financial engineering to drive returns. But the soaring cost of capital has prompted a renewed focus on growing the top and bottom line, according to market practitioners on the ground at SuperReturn.

“Our industry was getting paid to raise funds and get out and get deals done,” said an executive at one of the world’s largest private equity firms. “There was a collective delusion a year ago – deals still being done at 20x EBITDA with 9-11x leverage like it was normal. Add 500 bps and it’s no longer possible, it’s changed the way deal-making needs to be done.”

Sponsors appear to have largely shaken off the exit and fundraising woes that have dominated the past year’s market, with the mood buoyant at the InterContinental Hotel in Berlin, which saw its yearly gathering of private equity market practitioners including GPs, LPs and advisers between 6 and 9 June 2023. Many are now seeing opportunities to deploy selectively and to hone in on portfolio management to deliver on what many expect to be great vintages.

“Private equity is going back to the basics of alpha generation,” said one large multi-asset manager, adding that the industry is being forced to move away from its reliance on cheap money towards actually building companies. “The past decade has been to buy as much beta as possible, now revenue growth is the primary generator of return.”

The current environment has driven GPs to develop new tool books to deliver top and bottom-line growth. “Driving value, driving cash flows is going to be very important for the next decade of private equity,” said a second global asset manager, given that inflation and interest rates expected to remain sticky for the foreseeable future.

Value-creation takes many forms: from sustainable organic topline growth and driving scale through properly integrated add-ons, through to operational improvements in IT systems, cash management, digitalisation, supply chain resilience, manufacturing improvements and product innovation, said one consultancy, which delivered a presentation on the topic at the conference.

“It’s no longer the way that you can invest, let the management team crack on and rely on the market,” said one mid-market sponsor. “Although, from the other side, we’re also seeing more CEOs actually welcoming operational improvement partners when before we would have had to sneak them in the back door.”

Although everyone likes to talk alpha, naturally only few will achieve it. The largest asset managers, who can attract the talent, own the data and command the capital across multiple asset classes, have the best resources to help drive value creation, said one of the large asset managers.

This almost becomes a “self-fulfilling prophecy”, they added. Those resources will generate superior performance, leading to a wider gap between those that can and those that can’t.

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