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In this episode, Pete Witte, EY Global Private Equity Lead Analyst, reviews PE deal activity, that continues to accelerate while visibility into interest rate trajectories and macro volatility begins to recede.
PE Pulse is a quarterly report and corresponding podcast miniseries that provides analysis and insights on private equity market activity and trends.
Visit ey.com/pepulse to view this quarter’s summary and infographic.
PE remained resilient in 2023, as firms opportunistically deployed capital across a range of verticals, asset classes, and transaction types.
Key takeaways:
Deals: Deal activity ended on a high note – Q4 was the most active by value since the downturn began about a year and a half ago.
Exits: We’re still waiting for momentum on the exits front. That’s important, because about 80% of PE’s fundraising comes from recycled distributions.
Consolidation: As the industry matures, we shouldn’t be surprised to see more of those.
Private credit: 2023 was the year that private credit moved into mainstream.
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For your convenience, full text transcript of this podcast is also available.
Announcer
Welcome to the EY NextWave Private Equity podcast, where industry leaders come together to discuss emerging opportunities and industry trends shaping the global private equity landscape.
Pete Witte
Hi everyone and welcome to the latest edition of the PE Pulse podcast. We've just wrapped up a really interesting year for private equity. We'll give you a quick rundown of how last year shook out and some of the things that we expect for 2024.
All the important themes and trends and how we think the macro environment is going to impact private equity in terms of deployment, fundraising, financing exits and some of the longer-term impacts as well. And we'll also take a look at some really interesting survey data that we've been collecting over the last few weeks.
My name is Pete Witte and I'm the lead analyst for PE here at EY. Thanks for joining and let's get started.
So, let's start off by talking about deals. If we rewind to about a year ago, when we think about what sentiment looked like then, you know, there was just a tremendous amount of uncertainty out there. We had some economists that were calling for a really hard landing. We had others that were looking for a shallow recession. Others said we avoid a recession, but we'd see really anaemic growth and so market participants didn't really know what to believe. And what that did was it put the market into a measure of stasis where sellers didn't really want to transact based on atmospherics, so it could be really transient and at the same time, buyers didn't want to get caught holding the bag if macro really was going to deteriorate.
And so there were these parallax views that led to a really narrow transaction market in the first half of the year. We saw a lot of bargain hunting in the public markets with respect to take-private deals and a lot of add-ons, but there wasn't much else.
Mid-year though was sort of this turning point from a sentiment perspective. We started to see shops opportunistically put money to work into a broader array of deal types. And I think just overall start to feel more cautiously optimistic about the outlook.
Macro data since then, right, with central banks getting inflation under control, a levelling off of interest rates has really backed that outlook up. And so, we saw last year close out on a relatively stronger note where fourth quarter activity was the highest that we saw all year long. November in particular was an especially busy month. Second most active month of the last year and a half, firms announced just under $70 billion in new deals.
And so, as we move into the New Year, I think we expect a few things. The first is probably take-privates. I don't expect that activity is going to be anywhere near the proportion of investment that it was in the early part of last year, but the reality is that until pretty recently, you know, the breadth of the market recovery has been pretty uneven. And so there may still be bargains out there, where private equity firms can opportunistically invest. And indeed, you know, we saw one of the largest deals of the year in the fourth quarter, large take-private in the online classified space.
I think we'll continue to see add-ons, you know, there could be some regulatory headwinds here that might give pause to a few of these deals, but they'll continue to be an important part of the playbook. We'll also see more secondary transactions. You know, we just went out into the market with a representative survey of private equity investors and when we asked them what type of deals, they expected to see more of this year, secondary buyouts where number two on the list.
There's a measure of pressure amongst private equity firms to exit, at the same time the industry is sitting on more than a trillion dollars in dry powder, and so the conditions are just right for these kinds of deals, right, where companies can acquire them and take them onto that next phase of growth.
Number one in the survey was restructuring and distressed. Now we haven't seen a whole lot of these transactions so far, but if higher interest rates continue, opportunities are going to start to open up in some of the companies that were a little more aggressive in their use of leverage. SMP (Service Management Platform) for example, has something that they call the weakest link index, which is comprised of issuers that are rated B minus or below. They have a negative outlook. That index has grown by more than 50% over the last year. Now that's going to be highly dependent on rates, of course, and the degree to which refinancing opportunities open up over the next few months, but it's certainly you know something that firms are going to look at.
Now let's talk a little bit about exits, which is one of the, if not the most significant areas of focus for the industry right now. We know that a market recovery here is going to occur, right, the conditions for it are increasingly salutary, but the timing is still an open question. Buyers really stepped away from the market last year and so we saw just under 300 exits valued at about 320 billion, that's a decline of about 30% by volume versus the year prior and we didn't really see that uptick in Q4 like we did on the buy side.
And so, we continue to see a lot of interest in the secondary market. When we asked folks in our survey what their leading prediction was for this year, an increase in secondary sales and continuation funds was the number one response.
We're also likely to see continued interest in fund levels facilities. You know, we've heard a lot about NAV loans, they allow sponsors to support portfolio companies through these longer than expected hold periods and in some cases facilitate distributions back to investors.
Periods of volatility, they always tend to catalyse innovation, and those innovations often become part of the standard toolkit even after that volatility has passed, and I think that's likely to be the case here. And that's important because those distributions are required for new fundraisings. About 80% of the money that goes into new funds comes from recycled distributions. The rest is new, generally from new investors to the asset class or institutional LPs (Limited Partnership) increasing their allocations, but when the spigot starts to slow on that 80%, it makes raising a new fund a lot more challenging. And so, you know, when we asked survey participants about their top concerns for this year, fundraising was number 1 on the list.
In terms of some of the other things that we're looking out for, I'd highlight a few things. Number 1, alternative financing arrangements. It's hard to put a number on it, but we have seen anecdotal evidence throughout the year of transactions with features like earn outs and seller paper and that's something that probably continues into the New Year.
Number two is consolidation. We saw a number of consolidation plays across the private equity space last year, TPG's acquisition of Angelo Gordon, for example, was the largest of these. But as the industry matures as offering investors a diversified platform becomes even more important, we shouldn't be surprised to see more of these deals. And I think some of the fundraising challenges that we just talked about could be a driver here as well in some cases.
A continued focus on ESG, we're seeing increasing evidence that folks are leaning into ESG going back to the survey, when we asked folks to rate the degree to which they're leaning in on ESG and sustainability as a value creation lever on a scale of one to five, almost 60% rated themselves a four or five.
30% said they're looking holistically at ESG to help drive deal metrics and that they expect a measurable ROI on that investment.
Lastly, with respect to value creation, it's clear that to the extent a higher interest rate regime persists, it's going to continue to elevate the importance of operational value add. Results from a survey are very clear on this point that investors expect this to be the case. When we asked folks about the relative contribution of return levers for deals exited two years ago versus deals they expect to exit over the next 24 months, GPs (General Partnership) note significant differences in their relative sources of return. For deals exited at the peak of the exit market two years ago, multiple expansion was estimated to be the leading driver of return accounting for about 40% of total return. But going forward, firms expect multiple expansion to be about a quarter of returns. And more than half is going to be driven by that operational value add.
That's it for today's podcast. Thanks as always, for joining. We'll be back next quarter with some more views and an early read on how 2024 is starting to shape up.
Announcer
Thanks for joining the EY NextWave Private Equity podcast. For more insights and perspectives visit ey.com/private-equity.
