Many in private markets have been feeling whipsawed recently – snapped quickly from unprecedented deal activity in late 2020 through mid-2022 – to a much more subdued environment.
Zoom in: Global deal volume in H1 2024 was down 25% year over year with deal values at $1.3 trillion, reflecting a decrease of approximately 52% from the peak activity levels in H2 2021.[i]
- Despite these challenges, the private equity market closed 2023 on a strong note, which generated a high level of optimism coming into the new year.
- Optimism for an increase in deal activity quickly faded, however, as a fog of uncertainty rolled in once again leading to a precipitous decline in transaction activity in H1 of 2024.
Zoom out: What began as a period of unprecedented opportunity for firms leveraging deals at historically high multiples during the zero interest rate policy era (ZIRP) of 2008-2021, has gradually evolved into a nuanced challenge as interest rates have risen by approximately 5% within just two years – and are expected to remain at levels common before the ZIRP era, even after potential rate cuts widely expected to be announced in September.
- Price multiples, typically inversely correlated with interest rates, declined to the lowest levels in 15 years resting at 10.1x[ii] as sellers bring only their highest quality deals to market.
- This has exacerbated the “stare down” between buyers and sellers who have had misaligned valuation expectations – each side waiting for the other to blink.
Why it matters: Exit options of recent past have largely diminished, restricting the capital flow back to limited partners (LPs) and resulting in general partners (GPs) grappling with an overwhelming $4 trillion in unsold assets,[iii] of which $2.62 trillion is attributed to private equity.[iv]
Yes, but: As we enter the second half of 2024, the dealmaking environment seems notably brighter compared to a year ago, suggesting a potential uptick in M&A activity.
- Factors such as the prospect of somewhat reduced interest rates, still steady GDP growth, relatively low unemployment rates, and controlled inflation are all favorable indicators likely to stimulate M&A transactions.
- While higher interest rates have made deal financing more challenging, green shoots are appearing and deals considered “A+” are closing often with valuation multiples at 2021 levels for the right strategic fit.
- Additionally, with LPs monitoring distributions to paid in capital (DPI) more closely than ever, other capital solutions such as partial exits, dividend and minority recapitalizations, single and multi-asset continuation vehicles, and fund level NAV loans are being presented.
Future prospects remain optimistic, but resolving the current logjam requires innovative liquidity solutions and a renewed focus on “old-school” value creation.
Meanwhile, until GPs can begin to sell off assets from their portfolios it will be tougher to raise capital for the next fund, not to mention the real threat it creates to investment returns.
- Over the past two years, interest coverage ratios among buyout-backed companies have dropped sharply to 2.4 times cash flow in the US,[v] pressuring GPs to both find liquidity solutions, and devise new ways to generate profits through operating leverage.
What’s next: Amidst the layers of uncertainty, it’s clear that M&A activity will bounce back and getting unstuck will demand focused value creation – the type that was more commonplace prior to the ZIRP era.
- Dealmakers will have to adjust to the new macroeconomic normal of relatively higher rates.
- Companies that will command attention are those capable of sustainable organic growth and that can efficiently boost EBITDA while clearly demonstrating untapped potential to future buyers.
- Activating value-creation drivers such as digital transformation, technology enablement, organic revenue growth, margin expansion, and talent optimization must be part of the value creation blueprint going forward.
Go deeper: Stay tuned for the next article in Auxo’s series that will explore key drivers of value creation – in the new macroeconomic normal – in greater depth.
[i] PWC. PWC Global M&A Industry Trends, 2024 Mid-Year Outlook
[ii] Bain and Company. Bain and Company 2024 M&A Report: Looking Back at M&A in 2023
[iii] BlackRock. BlackRock 2024 Private Markets Outlook
[iv] S&P Global Market Intelligence. Private equity dry powder accelerated in H1 2024
[v] Bain and Company. Bain Private Equity Outlook 2024: The Liquidity Imperative