The near simultaneous global shutdown of many sectors due to Covid-19 has had immediate consequences for private equity (PE) firms. I lead Sponsor Coverage for Baringa and in my role, I am in close contact with deal teams, merger and acquisition (M&A) advisors and the operating groups of funds ranging from some of the largest to some of the smallest, from sector-agnostic funds to those focussed on specific segments. In my recent conversations, I have tried to understand how they were coping, what major issues the pandemic had exposed, and as a result, what the future might hold for the industry.
Feedback varied based on fund strategy and risk appetite but some recurring themes appeared. There are three major challenges the industry must address going forward, but new campaigns are emerging which could see a return to PE firms investing and playing a leading role in the economic recovery.
There are three key challenges PE funds must tackle quickly to re-position the industry for the future:
A lack of operational resilience has left many portfolio companies exposed
The current economic climate is severely stress-testing the operating models of many portfolio companies and placing a burden on the PE operating groups that support them. Realising that business-as-usual playbook assumptions are meaningless under current conditions, they are focussing on downside-protecting the operating models of portfolio companies and setting them up for success once the economic recovery begins.
Most PE funds conduct rigorous commercial due diligence on proposed investment targets to get comfortable with the size of the market, growth prospects and competitive threats. Almost every investment case has base, upside and downside scenarios but none typically assume an apocalyptic scenario, at least not one which includes a global shutdown of sectors.
While it is hard to plan for something this extreme, what has been lacking in due diligence processes is a lens on resilience under stress or scale scenarios. Going forward, operational due diligence best practice should assess whether a firm has the right capabilities in place in order to grow under normal conditions but also to survive a downturn. Getting this right will help ensure portfolio businesses are more resilient to whatever the broader market throws at them.
Timely decision-making is being hampered by the unavailability of data
PE firms that had the foresight to invest in comprehensive and automated financial-reporting infrastructure across their portfolios have been able to monitor critical performance metrics daily, without placing too much burden on management teams. Those that did not are now struggling to engage management teams in a timely manner or to take remedial action quickly. Reports of monthly or quarterly check-ins being replaced by weekly or even daily calls are common and reflect both the rapid nature of the crisis and the lack of automated data and insight available.
This universal thirst for real-time, quality data to feed decision-making has been magnified as critical timescales are now measured in hours and days, not weeks. Further, the data discussed is more detailed. Most portfolio groups are asking management teams for rolling 13 to 26-week cashflow forecasts, for example.
The availability of trusted data has been a known, but second order challenge for many years. The pandemic has escalated the issue which is now viewed as a priority by the majority of firms. Fixing this is fundamental to timely decision making and ultimately to their success going forward.
Existing investment thematics need a rethink
Covid-19 has disrupted the global economy and put additional stress into every industry. Investment themes that made a lot of sense a couple of months ago need to be carefully reconsidered in light of emerging trends.
With response-planning broadly complete across portfolios, some PE funds are already building a picture of future markets and thinking thematically about where to play. This ‘new space race’ is considering sectors and businesses that are likely to succeed through and beyond the Covid-19 crisis. We are seeing strong PE campaigns emerging across opportunities in and around the ‘Energy Transition’ – energytech, flexibility / storage, e-mobility and heat. More broadly, existing campaigns in fintech and healthtech are being pivoted around the most dominant themes emerging from this crisis.
Positioned to lead economic recovery
While not wanting to undermine in any way the immense humanitarian and economic challenges presented by this crisis, we know, as Persian poet Rumi did, that “this too shall pass”.
If the PE industry learns from the crisis and implements changes quickly so that it is ready to invest again, PE’s share of the UK economy could increase in a post Covid-19 world. With c.$2.5tn in dry powder to deploy, pricing becoming more sensible across the market, a very favourable low interest rate environment and continuing underlying dynamics driving M&A, PE could help kick-start the economic recovery.
If you would like to discuss any of the topics above or find out more about wider services we offer to support Financial Sponsors, please contact Chetan Chhatwal.