Private Equity Fund Managers Adapting To Covid-19 Effect on Portfolio Companies
The dramatic reduction in economic activity caused by Government lockdowns designed to slow the spread of the Coronavirus impacts all firms and is perhaps the most impactful single largest exogenous event in the private equity industry’s history. Private equity GPs must adapt to the new normal – however temporary – in order to ensure their portfolio companies survive.
That is exactly what they are doing, according to EY’s latest ‘PE Pulse’ report. The EY Capital Confidence Barometer Survey, which took place between February 10 and March 24 this year, shows that the proportion of PE executives modelling a recession jumped to two-thirds by mid-March, up from less than half in February.
Private equity GPs are focusing on five areas, according to the report: Assessing supply chains; Strategy refresh and revenue impacts; Understanding liquidity needs; Tax impacts, and Value creation.
“Right now, PE funds are working to define the “new normal,” said Bill Stoffel, EY US Private Equity Leader. “This means assessing everything from revenue losses to emerging business opportunities. Most of all, the goal is to mitigate the impacts of COVID-19 as much as possible.”
EY’s previous PE Pulse, published in January, claimed that private equity firms were too conservative in deploying capital during the previous recession – that of the Global Financial Crisis in 2008/2009 – and that they would be more aggressive during the next one. Few could have foreseen a global pandemic being the cause of such a recession, however. Consequently, Stoffel says that private equity GPs’ priorities have shifted.
“In the wake of the pandemic, many of our clients have expressed that their primary focus is on their portfolio companies and how they will proceed. PE funds see that the majority of their portfolio companies do have a path forward and have enough liquidity to navigate and survive the crisis,” he said.
ESG was also a significant focus of EY’s January PE Pulse, and the growth in the importance of ESG considerations at both the management company level and the portfolio company level has grown considerably in recent years. For now, these considerations will be taking a back seat.
“The primary mandate of every PE firm is to generate returns for its investors. ESG is absolutely a part of any fund’s focus, but profit-making remains the priority. I don’t believe ESG will disappear, of course. It remains a very important element, but it will not be the primary concern of funds navigating this crisis,” said Stoffel.
EY’s PE Pulse also looks at the private credit market, and says that leveraged loans trading at distressed levels has increased dramatically; 57% of U.S. leveraged loans are classified as distressed (where the value has fallen to 80 cents on the dollar) whereas just 4% of these loans were distressed at the year’s outset. Stoffel sees private credit managers facing similar challenges to PE managers.
“It will be interesting to see how the shadow banking system performs in this crisis, by balancing the need to shore up the portfolio and originate new loans,” he said. “There certainly is a lot of interest in doing deals once seller’s expectations reset and credit is a key part of that process for most PE investments.”
Financial and economic crises provide opportunities to learn lessons, and some observers have accused the private equity industry of not learning from the mistakes of the Global Financial Crisis, with the past few years showing deal multiples higher than they were pre-GFC. Stoffel thinks that this time, things will be different.
“This crisis will bring people issues into sharper focus for PE firms,” he said. “Private equity has always been a people-heavy industry, but the nuances of employee engagement and how people work will be increasingly important. The world became more virtual overnight and our industry must take that into consideration as we make decisions for the future.”
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