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10 February 2022 private equity update
The panel discuss the outlook for private equity, including the impact of increasing interest rates, the post-Covid world, and the increasing use of public markets by PE.
- Jonathan Arrowsmith, Co-Head of Private Equity and Head of Advisory
- Jon Harvey, Head of Client Relationship Management, Fund Solutions
- Helen Lucas, Co-Head of UK Origination in Growth & Leveraged Finance
- Emily Cvijan, Private Banker for Private Equity
Kicking off the discussion, Jonathan Arrowsmith, Co-head of Private Equity and Head of Advisory, reflected it has been a very strong 12 months for private equity (PE). A year ago, in the teeth of the second major lockdown, everything was doom and gloom – yet 2021 transpired to be full of activity. The industry saw record levels of deployments as investors made up for the initial pandemic hiatus, and exit activity was equally prolific, across IPOs, trade sales, secondaries, tertiaries and PE funds reinvesting alongside third party capital.
Based on this assessment, the speakers each gave their take on the upcoming year. Jon Harvey, Head of Client Relationship Management, Fund Solutions, first noted that although the higher yield appeal of PE may diminish in a rising rate environment, he does not see PE slowing down. Only growth assets, such as those in the tech and healthcare space, could start to come off, he said. Going forward, he was most excited about mid-market PE. “While this was previously the preserve of the KKRs of the world, the success of the Bridgepoint IPO last year shows the space is starting to attract institutional investment,” he said.
Meanwhile, Helen Lucas, Co-head of UK Origination in Growth & Leveraged Finance, predicted the post-Covid world will see more varied recovery profiles in underlying corporates, leading to a more art than science approach to assessing debt capacity. With one eye on interest rate rises, she also noted heady leverage levels might be pared back and highly structured payment-in-kind (PIK) facilities used to address the issue.
Arrowsmith added that while the assets coming out of PE are not quite as pandemic-resilient as in 2021, 2022 should see levels of activity that are not dissimilar to last year. A big feature of the market going forward, he said, will be more conversations around IPO exits, continuation vehicles, and funds rolling investments into new funds alongside third party capital – beyond the two classic exit channels of trade or PE sales.
From an individual perspective, Emily Cvijan, Private Banker for Private Equity, said faster-than-expected deployment for funds means many private equity professionals are facing a pinch point, having to fund co-investments before distributions are made. To avoid liquidating, she explained people are looking to leverage their existing assets – exploring mortgages, revolving facilities secured against main homes, or borrowing against an investment portfolio.
With PE funds getting bigger and bigger, we are witnessing a ‘war for talent’ at junior and senior levels. What does this mean for the industry?
Cvijan said: “At a personal level, this can mean great things, but ultimately, it translates into bigger buyouts and compensation offers than I ever recall seeing – used both as a retention and a hiring tool.” She explained her team has been increasingly speaking to individuals about cash sign-on bonuses and guaranteed cash distributions. On the flipside, she said management teams are considering solutions for individuals who are looking to solve cash flow issues when funding commitments.
Harvey added that historically, it has been hard for banks to judge what can be quite lumpy cash profiles for junior members of staff. However, he said as the industry matures, we are seeing greater appreciation for individuals’ earning profiles.
With regards to PE-backed businesses, Lucas said the war for talent is also creating competition for top management teams and board level positions, and wage inflation is putting pressure on the bottom line, particularly for human capital intensive businesses.
We are on the path out of Covid-19, but uncertainty remains. What can we realistically expect for 2022?
Lucas explained a key feature of the Covid-19 recovery is the divergence between debt and equity. She said: “Equity as a forward-looking assessment remains relevant, and perhaps has led to new opportunities, but debt as a traditionally retrospective assessment has become more challenging following a period of disruption.” While this will impact debt quantums, she noted there is an abundance of debt in the market as well as creative structuring solutions.
On the M&A side, Arrowsmith said 2022 should see similar pricing to 2021, which could even rise for the best businesses. He explained that investors are still willing to pay up for top quartile investments, because whether they take three or five years to realise their potential, these premium assets will deliver.
Regarding fund solutions, Harvey said we will see more thinking around secondaries and continuation vehicles. Over the last 12 months, he noted a significant uptick in single asset continuation vehicles, driven by investors not wanting to let go of good assets which they think will rise further. Arrowsmith added that this fits into the broader transition to longer hold periods across PE.
Harvey also said with increased fund sizes, demand from investors is pushing the limits of how much capital banks can provide, and we are witnessing innovation around how to institutionalise this debt. As funds continue to play an increasingly strong role within the leveraged finance market, Lucas said the banks are fighting back. In partnership with other providers, she explained banks are now able to speak for bigger cheque sizes and compete with unitranche debt providers, as well as private debt funds. “It is important to keep in mind that banks offer something different – they are more open to redraw and undrawn facilities and super senior structures,” she added.
At Investec, Cvijan said her team is working hard to support clients that require access to debt. She explained: “We plan for the cyclical nature of personal balance sheet management and make sure we are there for clients at every step of the way. When commitments are upcoming, we examine opportunities to leverage assets. As individuals come into increased liquidity, we work out how to make the most of it alongside the inevitable growth that will come from PE returns.”
With the UK property market forecast to grow by 7% in 2022, Cvijan said many PE executives are wondering how to make the most of this outperformance to fund further investments. While most high street lenders struggle to increase debt if basic salary hasn’t risen, she explained that Investec looks at the total comp package, including the value of co-investment, track record over the last three years, projected comp, and expected distributions from carry pools.
How is PE increasingly leveraging the public markets for its purposes?
A clear theme that emerged from the discussion was the increasing use of public markets by PE. Harvey views the IPO of PE firm Bridgepoint last year as a game changer, which will accelerate planning around succession and expansion for many mid-market GPs, who previously may never have considered going public. For firms with significant assets under management, he said listing can be a good way to facilitate cash flow and fund further investments. However, Arrowsmith explained firms need to prove minimum recurring revenue and come to terms with the disclosure requirements for floating.
Arrowsmith added that with growing asset and fund sizes, the IPO route for PE exits is also becoming more viable. However, he warned the IPO process is very different from selling to PE and trade, and GPs need to have a solid understanding of the valuation process and appetite for sector assets.
How are supply chain constraints impacting refinancing and PE business plans? How do you mitigate this?
For certain sectors, Lucas said supply chain constraints require a lot of brain power to assess the risk and structure around it. One way to do this, she explained, is to use more flexible asset based lending, while working capital can also help a business restart growth after a recovery period.
At the GP level, Harvey said the uncertainty around supply chain issues is putting pressure on the repayment of short-term NAV facilities. Where the long-term prospects of an asset are promising, he said GPs are increasingly looking to continuation vehicles instead.
Will the IFA sector ever become a long-term hold for PE?
Arrowsmith responded by saying Investec is a big fan of the IFA sector from an M&A, fund solutions and growth and leveraged finance perspective. He explained that the sector will only grow as the sophistication of funds investors can access increases – and having intermediaries behind this will be important. While not a high growth sector, he said it is resilient, as well as fragmented, with immense consolidation potential. These characteristics lend themselves well to a long-term hold in Arrowsmith’s opinion, and Harvey said he is already seeing increased appetite from PE buyers that typically lean towards growth areas.
To wrap-up, Arrowsmith concluded PE is going into 2022 in rude health – with ever increasing fund sizes and capacity for co-investment on the horizon. While this will come with challenges in the structuring of debt and the funding of co-investments, he explained this should lead to even more creative solutions. Meanwhile, he predicted the use of IPO and continuation vehicles will continue to grow as a bona fide exit route for PE funds.
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