If the Global Financial Crisis (“GFC”) was a disaster to the financial sector, the COVID-19 pandemic is a catastrophe (if not armageddon) to the businesses and economies worldwide. The loss of lives, the shutting down of schools and businesses, the travel restrictions, the increase in unemployment rate… have all caused fears that the world economy will enter into a recession. Despite governments and central banks pumping trillions of dollars into the monetary system, the IMF said the world will face the worst economic crisis since the Great Depression of the 1930s. Can these stimuli alone save the world? How can private equity play a role in today’s predicament?
Private equity has gained huge importance and influence since 2000. In the U.S., the number of listed companies decreased significantly in the past decade; while the number of private equity-backed companies more than doubled. The public markets in the Western world continue to shrink as private markets alone often are able to provide adequate capital to finance businesses to grow and mature. In addition, the private markets AUM has grown from approximately $1 trillion in 2000 to over $7 trillion in 2019, and shows no sign of abating. Analysts expect the industry’s AUM will reach $17 trillion by 2023. As investors pour money into this asset class, private equity is no longer a niche but a mainstream strategy. Institutional investors consider it an important part of portfolio allocation and view it as imperative as the traditional asset classes like bonds and equities.
The COVID crisis is unprecedented and may have a long-lasting effect, and presents a new form of challenge to all aspects of businesses such as supply chain, production capacity, operation, cash flow management and business model, especially when countries implemented various degrees of confinement and social distancing measures. Going forward, businesses will need to transform and adjust, industries and sectors will revolutionize, and consumer behavior and habit will change. Companies failing to adapt, innovate and digitalize will face difficulty surviving. Private equity can play a pivotal role in supporting these businesses to reposition – some industries will thrive while others will shrink. It is important for investors to focus on the more resilient sectors, such as healthcare, technology, education, and food. Consumer retail may continue to face some headwind for a period of time.
The current COVID crisis, of course, also presents challenges to the investment and divestment activities. Investing in private companies is not an easy task. It requires ample resources and local expertise to perform due diligence on the target being acquired. It also involves multiple discussions with various parties such as consultants, lawyers and bankers to structure a deal. With lockdowns and travel restrictions, the number of transactions will inevitably decrease and investment activities unlikely to resume before 2021. Divestment activities have already slowed, as valuations have suddenly dropped, and companies shifted their focus on fixing business disruptions. It is expected that normalcy will only return in 12-18 months.
In the past five years when the market was robust, private equity generated ample liquidity by exiting portfolio companies via trade sale, secondary sale or the IPO market. As valuation is suppressed as a result of the uncertainty brought by the surge of infected cases and timing of vaccine available, private equity managers tend to hold on to the portfolio companies longer. In the coming two to three years, investment activities, albeit slower than the past, will outpace exits, resulting in net capital outflows for investors.
Today, private equity is sitting on $2.7 trillion of dry powder, a ten-fold increase from two decades ago. The vast amount of unspent capital can help provide solutions to companies under stress, and carefully capture opportunities as they arise. Further, the private debt market, which has seen a rapid growth from $42 billion at the start of the millennium, to over $819 billion in 2019, has provided an alternative source of capital for LBOs and business transformation. Last but not least, the secondary market has matured and become more sophisticated. This provides liquidity to both private equity managers and investors who need to restructure or offload portfolios.
Private equity is well positioned to weather the current downturn. The industry is now in a much better shape. In the past, private equity managers focused on multiple arbitrage, leverage and top line growth to generate value. Post GFC, the focus has been shifted to operational improvement. Private equity managers emphasize on hiring operating partners and sector experts to assist with the reshaping, growing and transforming of portfolio companies. Strategic transformation, including digitalization, production relocation, cash management, operational continuity and targeting new consumer habits are key to success.
Private equity has demonstrated its resilience, generating positive and mostly double-digit returns over different cycles. Although the 2016- to 2018-vintage funds may face some performance pressure as market was robust and valuation was high, the coming years could be an opportunity for outsized returns, as in the post-dot com and post-GFC eras. During the difficult periods, private equity managers are able to support their invested companies by providing capital, and working more closely with management teams to tackle issues and respond to economic dislocations.
The impact of COVID will persist for some time. In light of the challenges ahead, private equity will continue to adapt and evolve. The “entrepreneurial spirit”, and the resilient and flexible nature will help the industry survive and thrive.
The views expressed in this column are the author's own and do not necessarily reflect this publication's view, and this article is not edited by Asian Banking & Finance. The author was not remunerated for this article.
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Olivier Carcy is the Global Head of Asset Management at Indosuez Wealth Management. He began his career in Paris with Paribas (now BNP Paribas) before moving to Rothschild. He joined the Crédit Agricole Group in 1997, where he worked in structured asset financing, a role that took him from Paris to Singapore, then to Jakarta. He relocated to Geneva in 2000, where he set up a dedicated private equity asset management platform, making Indosuez one of the first private banks to incorporate this specific asset class into wealth management. Until 2019, he was heading the private equity business line across all entities of the Group Indosuez.
Brenda Lau is the Head of Private Equity, Asia, at Indosuez Wealth Management.
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