Optimism prevails as PEs expect step-up in deal-making – research

The Mid-market Private Equity Forecast: 2022 broke down respondents’ answers into three categories based on the size of their most recent fund: less than EUR 50m; EUR 50m-500m; and more than EUR 500m. Of these categories, 26% of larger mid-market funds anticipated a “significant increase” in deal-doing, versus 13% of GPs whose latest fund was in the EUR 50m-500m range, and just 3% of GPs with funds of EUR 50m or less (most likely due to the limited size of these funds not allowing for a significant deal-doing step-up).

The survey collected responses from 114 senior executives from sponsors based in markets including the UK (23), France (23), DACH (24), Benelux (22), and Denmark and Norway (22). Of these, 30 firms stated the size of their last fund was less than EUR 50m, 53 stated that it was in the EUR 50m-500m range, and 31 stated that their last fund raised more than EUR 500m.

Joshua Maxey, the co-founder of Third Bridge, told Unquote that this positive outlook comes at a time when many market participants are having to think about how long any potential downturn will last. “The level of optimist in the PE market is definitely holding,” he noted. “But it’s still very hard to know if the market dislocations we are seeing are long or short term and there is a lot of uncertainty. Some argue that the effect of the war in Ukraine will be limited and that inflation is only indexing against a certain period. But another camp is saying that it will take a decade to work this out, with a slow, prolonged recovery. But there is a lot of dry powder overhang and plenty of companies who need funding – because of that, dealflow has not really slowed down. Private equity is still engaged and expecting a lot of deals.”

The report noted that a significant difference between the current market and the GFC is the penetration of debt funds. While banks might shy away from providing financing in challenging conditions, debt funds will remain an available (albeit often more expensive) option.

“Another factor to bear in mind is that the portion of LPs’ allocations to the PE market is still comparatively small versus public equities, so the PE industry is still expecting a fundamental shift to more allocations going into the private world, which is another reason for optimism,” Maxey said.

Exit options
Although most GPs in each fund size category expect the number of divestments they will make in the next year to “increase slightly” or “stay the same”, funds of more than EUR 500m were an outlier, with more than a quarter (26%) expecting divestments to “increase significantly”.

When it comes to specific types of exits, optimism also remains for IPOs as an exit route, with 61% of UK-based participants saying they intend to pursue this exit route in the next year, along with 50% of Benelux-based GPs. In France, the DACH region and the Nordics, less than 40% of participants said they were considering this option. After the worst of the coronavirus pandemic, 2021 was a record year for IPOs in the market thanks to a quick correction. However, it remains to be seen whether the same will happen this time around.

Almost half (48%) of French respondents said they were likely to pursue a minority stake sale in the next year, although this exit route did not pass the 40% threshold in any other geography. Majority stake sales remained broadly popular, with more than half (55%) of Benelux-based GPs and half of DACH GPs saying this is a route they could pursue next year.

Valuations and specialisation
While geographical differences were evident in GPs’ views on exits, views on valuations were most starkly different between different fund sizes. Survey participants were asked whether they expected the average value of their firm’s new acquisitions to increase or decrease in the next year, with just 20% of funds of less than EUR 50m saying they expect them to increase, versus 51% of funds of more than EUR 500m. The smallest GPs and GPs with a fund of EUR 50m-500m were the most likely to say that valuations would decrease, with almost a quarter (23%) of each group stating this, versus just 16% of the largest GPs.

The differences in view might be down to the types of businesses each firm is targeting, given the significant differences across sectors. “What we have heard from our clients is there is definitely a continuing level of support for valuations on businesses that are not as exposed to inflation, that can maintain pricing power, and are protected from supply chain disruption,” Maxey told Unquote. “We also wouldn’t expect to see a correction for companies that are uniquely positioned to take advantage of global trends, such as cybersecurity.”

However, some businesses are likely to command weaker multiples than they might have done this time last year. “Some other businesses will continue to see markdowns and will struggle to command the high multiples they have in the past,” Maxey said. “Some of the valuation metrics used in the last few years were bubble-like and exuberant and needed a level of correction at some point.”

In a market where competition for the best assets is ever-tougher, more than half of the largest fund group (>EUR 500m) said that they will focus on diversifying into new industries as one of their top two options, while 61% said they would focus on diversifying into new geographies. Perhaps unsurprisingly, all of the managers at the smallest end of the scale ( < EUR 50m) said they would keep specialising in their existing geographies, and 83% said they would be specialising in their existing industries.

Sponsors will need to bear in mind that the way they might go about their deals could be different from last year. “One trend that we didn’t address in the report, but we are hearing about from our clients, is that deals are taking longer to close, and the cycle has been prolonged a little,” Maxey said. “This is not leading to anything meaningful in terms of valuation markdowns, but people are not rushing as much as they were in previous years. 2021 was bumpy due to pent-up demand, so many people might have been entering this year feeling a bit hungover and are realising that they don’t need to rush.”

To view the full report on Mergermarket, click here.

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