CORONA-Impact: For Private Equity, history repeats and markets learned from it

Private Equity (PE) is sitting atop $2.5 trillion dry powder in the form of uncalled capital, including $800 billion in buyouts. As valuations fall in the wake of the lockdown, General Partners (GPs) have to channelize these funds. Plus, the companies with dropped valuations have excellent fundamentals. Banks’ reluctant to lend make Private Equity a preferred investor. Legal and valuation uncertainties can slow down the forward march of the Private Equity sector as can inflation-inspired interest rate hikes, falling returns, and the reluctance of Limited Partners (LPs) to allot funds to an already expanding component of their portfolio

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COVID-19 crisis is an opportunity for PE, just as the 2008 global financial meltdown was 

Private Equity (PE) has had a great decade leading up to the COVID-19 pandemic. Private Debt took off after the 2008 financial crisis. Today, they have over three times the assets they had back then under management. At present, PE is sitting atop $2.5 trillion dry powder in the form of uncalled capital, including $800 billion in buyouts:

As valuations fall in the wake of the lockdown, General Partners (GPs) have to channelize these funds. This is an immense opportunity for PEs because while valuations are low, the inherent value of companies is high

Banks will suspend lending, which provides GPs the opportunity to direct funds to distressed borrowers. In crises such as the present one, PEs are preferred funding source for mezzanine funds, strategically important M&As, or distressed funding. 

There will be less competition for PEs for investment with public markets in temporary flux and corporate buyers reluctant to invest or acquire. Limited Partners (LPs), particularly the institutional investors benefited from diversification during the 2008-09 downturn. They are most likely to repeat the same during this slump. 

Possible speed slowers

Legal uncertainty as to whether the COVID-19 pandemic is a Material Adverse Effect (MAE) i.e. something that negatively affects the financial status or existing and future business of the target company. MAE clauses are common in PE agreements and allow the investor to withdraw

Valuation uncertainty is another challenge. PE investments into listed companies have regulatory floor price based on average of low and high weekly prices of 26 weeks before deal approval. At present, this duration period goes before the crisis period and presents a high regulatory price. Deals will be postponed till this 26-week duration better reflects the present situation.

Although GPs are unlikely to sell for want of the proper price, they can exit once the market improves. With GPs not exiting the market at present, LPs may not have enough funds to invest. Returns from PE may drop in sync with the overall market decline although the reporting durations will conceal this for some time

An LP that has a portfolio with private plus public equity could be reluctant to further invest in private equity because falling values of public equity have inflated the value of private equity relative to that of the public equity

Lockdowns and supply chain disruptions can push up inflation and force central banks to hike interest rates. This will make borrowing costlier and recovery harder for PE investors

History repeats and LPs have learned from it

PEs performed great during the 2008-09 crisis. Limited Partners know this and will definitely cash on. 

 

Stay tuned as we update you on the latest in the world of private equity from around the world.

 
 
Albert Finch
Head of Research
Rodschinson Investment Strategic Research Center

corona-impact, private equity , chief economist brief