It’s an uncertain yet exciting time in the markets. Debates continue about the direction of Fed Funds and interest rates, wage and inflation pressures and the likelihood of a soft vs. hard landing. Despite what some perceive as an exceedingly challenging investing environment, there is ample reason to be bullish about the prospects for the private equity asset class.
My sponsor colleagues and I had the pleasure of attending several sponsor Annual Meetings over the last few weeks and found several reasons for optimism, four of which we detail below:
A Coming Wave of Corporate Carveouts
The public equity markets will continue to offer excellent investment opportunities for private equity including divestitures, take privates and PIPEs – and corporate carveouts in particular.
As companies across sectors have been forced to right size and down size, it’s becoming clearer which ones have divisions that may be underinvested, with strategies that may not align with the parent or management teams that lack the necessary decision making authority. Carving out these divisions into standalone businesses can be a minefield, as it requires intense work and presents M&A and operational complexity. But corporate carveouts done right also present enormous opportunity, and they have represented some of the best performing investments in private equity.
Private equity is particularly well-suited to lead these carveouts because they often have:
- Expertise in negotiating transition services agreements and identifying excess costs.
- Understanding of the complexities of transitioning accounting, financial and IT systems and building a new culture and corporate identity for the carveout business.
- Executive and operational experience through senior advisors.
- The capital to support add-ons and new capital projects.
- The ability to create an exceptionally talented board that can create the right incentives for management.
Growth in Leveraged Loans
Tightening fixed charge coverage ratios will increasingly necessitate corporate deleveraging and require junior capital solutions. A majority of direct lending loans, for example, still have maintenance covenants with cushions that are shrinking. That’s why we are witnessing more credits that will require a capital solution and why we expect more opportunities in the second half of the year.
Many corporates will turn to private equity for structured junior capital, debt buybacks, maturity extensions, up tiering exchanges and self-help junior capital investments. Private equity is well positioned for many of these opportunities given their fund flexibility, new pockets of capital and recycle provisions allowing for up to three years to recycle capital in many cases.
Family-owned Businesses in Transition
Family-owned businesses represent 55-60% of US GDP and are often small and mid-cap companies being managed by 2nd and 3rd generations that are focused on succession and wealth preservation. Many are now seeking capital as part of generational transitions and we expect the trend to accelerate given a more uncertain economic outlook and future tax environment.
Generational opportunities are not listed in any database and require extensive relationship building. They are fraught with challenges but private equity often represents the best source of capital given many of these companies are not exiting via the IPO market given their small and mid cap size.
This is an area where private equity has an excellent history of great returns and generating far greater wealth for families that roll their equity stake.
Jefferies has been leveraging our firmwide footprint in many local markets and deep banking domain expertise to identify family-owned businesses and curate introductions within the private equity community. We host ten private company summits each year across many industry verticals and sub verticals and these venues have historically been an excellent forum for family owned businesses to meet several private equity firms and start building a longer term relationship given the importance of finding a “right partner.”
Data and Digital Technology Driving Operational Improvements:
Private equity is often intensely focused on operational improvements at their portfolio companies and has several tools to deploy across an entire portfolio of companies ranging from talent management and recruitment to procurement and other scale advantages. More recently, they have focused on two additional strategies – data analytics and digital technology – to transform businesses. Many private equity firms are finding great success leveraging data to:
Many private equity firms are finding great success leveraging data to:
- Generate incremental revenue streams. Sponsor portfolio companies have vast amounts of data and are starting to hire internal and external teams to help monetize it.
- Source and conduct diligence on new investment opportunities.
- Assess their portfolio company’s suppliers, customers, new entrants and leveraging this data to acquire a new standalone platform in an adjacent market.
Although many investors are approaching this investing environment with caution, private equity is adapting with more tools and more creative methods to unlock value and create superior returns for their LPs. In short, we believe the latest vintage of PE funds will exceed expectations and continue to outperform public equities.
Jeff Greenip is a Managing Director and Global Head of the Financial Sponsors Group. Jeff joined Jefferies in 2008 after holding senior positions at Bear, Stearns & Co. Inc. including Co-Head of Global High Yield Syndicate. Jeff has an MBA from Columbia and a BS from Georgetown University's School of Foreign Service.