Cash-rich PE firms waiting for clarity

Hogan Lovells Deal Dynamics

Many sponsors remain active in raising capital, and those investor commitments will create new pressures on PE firms to invest over the next five years.

The pandemic has made it very difficult to run traditional transaction processes, such as auctions and in-person management meetings.

Still, there are some pockets of activity in distressed industries, including entertainment, hospitality and manufacturing, and life sciences and health care, that will likely continue to be focal points thanks to long-term demographic drivers.

As the first half of 2020 came to a close, Deal Dynamics spoke with Dr. Matthias Jaletzke, Frankfurt-based Hogan Lovells partner, Global Head of our Private Equity & Funds practice, and Head of the Private Capital industry sector, about the current state of private equity firms, which in aggregate have unprecedented firepower with US$4 trillion in assets worldwide to deploy. Dr. Jaletzke spoke about efforts for PE firms to raise even more cash — and what he expects them to do with the funds and when.

What’s the overall environment like in terms of PE fundraising? Has coronavirus slammed on the brakes?

Across the board, we’re continuing to see fundraising. We see large private equity firms, such as Clayton Dubilier, Bridgepoint Capital and Cathay Capital, among others – and smaller firms looking to buy small and mid-market companies – in the market raising money. Raising capital hasn’t been easy. Limited interaction has inhibited efforts on many fronts. But, overall, many sponsors are being active fund raisers. It’s important to remember that at this point the investors are just making available commitments and not actual payments. For many of the firms that have a traditional five-year investment time horizon, the clock has started for when they need to put this capital to work.

With their cash piles growing, do you expect to see a flurry of transactions?

Not really and not right away. The reality is that the dealmaking environment remains very much impacted by COVID-19, whether it’s in countries still in lockdown or those relaxing restrictions. I see a lot of hesitancy overall. One reason for that is that it’s very difficult to run transaction processes – particularly auction processes – the way most investors are accustomed. PE investors try to get a good impression of management teams; this is easier in person and practically very difficult now. Another important factor is the uncertainty within many sectors as to how the businesses will actually develop. Some areas have been particularly hard hit – real estate, hotels, entertainment, among them– and so have areas where you wouldn’t expect it, like some segments of the health care sector, where you’d anticipate stable performance. It’s just too unclear how the numbers will turn out for the year – even if companies think they have enough cash.

So, most of the funds are sitting on money and commitments and don’t feel the need to invest it immediately. They’re also in a wait-and-see mode as far as whether a second COVID-19 wave materializes and how quickly investments, customers and consumers return.

Are there any exceptions in terms of areas of activity?

Yes. While I see general cautiousness, we’ve seen activity in various distressed areas, such as the entertainment and hotel sectors and some in manufacturing. Some of these companies need to sell to survive. It’s likely we’ll see most of the activity in the next few months in these dislocated and distressed sectors until clarity begins to emerge for other sectors.

Also, there’s a bit of activity in companies opportunistically selling assets to use the proceeds to fund other assets –portfolio optimizations that will create buying opportunities for PE firms. This isn’t characteristic of any specific industry, but rather something we’re seeing in a number of sectors.

A recent article in The Economist noted that PE funds deployed during the economic crisis in 2007-09 ended up yielding a median annualized return of 18 percent. Are PE funds being too conservative now given this track record for taking advantage of downturns?

While in the past many PE firms looked to market downturns as opportunities to invest, the situation is a little different this time. Sure, there are some similarities. Like the world recession a decade ago, there is a lot of uncertainty about the length of recovery. For many manufacturing and service providers, it was years before a rebound fully materialized. And here we are today in similar circumstances – unsure of the timing of a recovery.

But the big difference this time is that the impetus of this downturn wasn’t inherently traceable to a distinct set of economic failures – it was the coronavirus pandemic. The uncertainty is therefore more pronounced now – in fact, it’s not clear that all companies will survive. COVID-19 has accelerated changes across a number of sectors, and some will find that their fundamentals won’t fully recover, if they recover at all. So the hesitancy, the caution, seems justified. And I expect a lot of activity once there’s increased visibility.

Are there any particular sectors that you expect to be targeted when there is more visibility?

Many old-economy firms are turning into tech firms. Car manufacturers are evolving into tech companies and competing with traditional tech companies on the future of the car. As a result, we expect tech and software M&A to be very prevalent going forward.

Life sciences and health care will continue to be important focal points for consolidation going forward as populations age and the cost of providing care increases. A lot of money is pouring into research and development in genetics and in curing diseases. PE firms typically look for exits in three-to-seven-year time periods so they have shied away from Big Pharma because of the risk profile and length of the cycle of new products and testing. But I expect they’ll be active in other parts of health care, from logistics to software to hospitals.



Authored by Dr Matthias Jaletzke.


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