The Private Equity market in the midst of the Covid-19 crisis

The Covid-19 epidemic is serving as a new stress test for the Private Equity asset class. While it is still too early to reach definitive conclusions on the long term impact of this ongoing crisis, one can already anticipate some emerging trends. We strongly believe that Private Equity investment managers will continue to play a strong and growing role in the investment landscape and act as a catalyst to the economic recovery post Covid-19 crisis. 

Investors’ sustained interest for Private Equity is well illustrated by the level of dry powder available in the asset class which has reached an all-time high of USD 1.5tn globally in December 2019 according to Prequin. The business model of private capital asset managers has proven extremely resilient since their funds are generally structured as “closed-end funds” which has contributed to the stability of the asset basis, guaranteeing the amount of dry powder available during the crisis. Moreover, the new allocation to the asset class has continued to grow as Limited Partners (LPs) are looking for higher returns in a low interest rate environment and given subdued public equity market performance. Some of the leading Private Equity franchises including CVC, EQT and CD&R have been able to raise significant capital during the crisis exceeding by a significant margin fund size of prior vintages. CVC Capital Partners, for example, has closed its flagship Fund VIII at EUR 21.3bn in July 2020 (EUR 3,8bn above its EUR 17,5bn original target), illustrating the continuous trust of LPs in the asset class and CVC as one of the best in class managers. 

The coming of age of the Private Equity industry is underlined by its demonstrated ability to weather several economic and financial crisis. While we expect the ramification of the Covid-19 crisis will continue to impact capital markets in the next few months and years, we strongly believe that our financial sponsor clients will continue executing on high quality and educated investment strategies. General Partners (GPs) will act on all levers available to build solid equity cases for their companies, not only by leveraging economic cycles and financial structuring, but also by supporting their portfolio companies in building a comprehensive industrial project with tangible standalone and external growth options and actionable operational improvement. In this context, the concentration in funds under management is very likely to continue with the larger firms becoming larger as LPs will seek top decile performance and consistency over several vintages. 

PE GPs have also learned from the subprime crisis that a “wait-and-see” attitude was not optimum since 2009 and 2010 were amongst the best vintages historically. Some firms have decided as a result to accelerate capital deployment since the spring of 2020 so as to capture “low-cycle” opportunities. KKR is probably one of the best examples with several billions euros of equity deployed in Europe since the beginning of the crisis in transactions such as the acquisition of Spanish telecom operator Masmovil¹ (c.EUR 5bn EV) and the acquisition of French hospitals operator Elsan² (c.EUR 3.5bn EV). 

In the meanwhile, it is also apparent that the Covid-19 crisis has had significant impacts on several Private Equity owned companies from either an operational or financial perspective or both. This has translated into an increased focus of GPs on portfolio management sometimes at the cost of any bandwidth to explore new opportunities. The most affected portfolio companies were moved into “hibernation” mode in order to preserve the cash position in the context of the brutal impact of lock down measures that were imposed on businesses. The fight for liquidity resulted in several sponsors and portfolio companies seeking government guaranteed lines, many of which BNP Paribas led and supported. Another category of assets has moved directly into debt restructuring when the leverage situation was judged not sustainable. In some cases, however, other solutions, sometimes industrial, were found as demonstrated by the combination of BUT and Conforama to form a domestic champion in French furniture retail under the ownership of Mobilux³ (owned 50/50 by CD&R and Lutz). Overall, we expect that our clients may need to hold assets longer on average to reach the desired and targeted returns. This could lead in turn to the lengthening of the fundraising cycle from 3-4 years in the recent past to 4-6 years going forward. This would however be a reversion to the historical mean. 

A combination of a limited number of assets, historically high dry powder levels and cheap financing had driven LBO valuations to historical record levels before the Covid-19 crisis with average EV/EBITDA of c.11x for European transactions in 2019 according to S&P Global (versus 9,7x in 2007). As Covid-19 crisis struck, public markets witnessed a rapid drop of all the major indices followed by a relative rebound for the most resilient sectors. The impact on private markets was different, as mostly felt through a decrease in volumes in H1 2020 while prices paid reached a new record at 12,7x average EV/EBITDA in Europe (Source: S&P global). These numbers should however be considered carefully as most of the deal activity took place in the more resilient and expensive sectors. Indeed, while some industries like Aeronautic & Defence and Retail have been severely hit by the Covid-19 crisis, others such as Consumer & Healthcare, Business Services and TMT have proven extremely resilient. As a result, PE funds have gone into more aggressive portfolio management accelerating the disposal of their most resilient and best performing assets, while delaying potential sale of other portfolio companies by a few quarters or years in order to allow for the underlying business to bounce back. 

This valuation bifurcation between listed and private markets has also pushed some of our clients to continue scouting for value opportunities in the public equity markets. This already translated into a number of Public to Private transactions and PIPEs (Private Investment in Public Equity) taking advantage of a short term volatility. For example, BNP Paribas advised KKR on its Public Tender Offer launched (alongside the de Bentzmann family) on the French technology consulting group Devoteam, valuing the group at an enterprise value of c.EUR 750m. Several PIPEs also got executed including the investment of Advent and Alibaba in Dufry as part of the CHF700m rights issue underwritten by BNP Paribas as one of several joint global coordinators. 

Private Equity managers will certainly play a key role in driving the upcoming economic re-equitization cycle with debt / equity rebalancing as per the transactions described above and asset disposals. Several large corporates are continuing to adjust their business portfolio for different reasons, and carve-out certain businesses or divisions to refocus management attention on “core” activities. We anticipate that this crisis will result in an acceleration in the flow of corporate carve-outs coming to markets in the next couple of years. 

In addition, Private Equity GPs can serve as a key engine for the acceleration in digital and energy transitions that some companies may decide to engage upon. These transformations are indeed easier to plan and execute when required under private hands than when publicly listed and under pressure of delivering quarterly results. BNP Paribas has been actively helping our sponsor clients to set the right financial framework around their ESG commitment, as we have done with EQT and Eurazeo in H1 2020 through the advice provided on implementing the first ESG Private Equity capital call facility ever and the first ever Sustainable Linked Loan for a private capital manager respectively. 

Finally, the Covid-19 crisis has exacerbated the need for less conventional sale processes. Indeed, over the last few months, standard auction processes have given way to more targeted or unstructured processes (“process non process”) with a limited number of highly motivated contenders selected and educated in a soft pre-marketing phase. This provides an ability for the seller to accelerate discussions during the chosen window by encouraging preemptions based on all the work done during the warm up phase while maintaining a lot of optionality. Conversely, assets are less likely to be tarnished by a failed auction if this unstructured process does not lead to a transaction. In this context, it is increasingly important to select knowledgeable M&A and financing advisors who can demonstrate the required agility in order to navigate these uncertain and volatile market environment.