In public markets, a well-known proposition is that at the moment that everyone steps in, the red flag should be raised: probably the best time is over. Investors in private markets, where effects are generally felt later, do not worry so much. Besides, there is not much you can do as a private investor.
Providers of private equity investments say they have never seen so many new clients and additional investments from existing clients as this year. US consultancy Bain & Company recently calculated that in 2021, private equity investors had the second best year ever for raising capital.
Investment companies meanwhile warned in Dutch financial daily Het Financieele Dagblad of impending price declines for the companies they own, mainly due to rising interest rates. The private equity hype seems to be over, the newspaper concluded.
On the investor side, these concerns are not shared as yet. Asset manager Schroders, which aims to double its invested assets in private markets by 2025, speaking through Wim Nagler, that it still saw “hardly any reaction”. “The biggest impact is that the market for IPOs is closed for the time being,” said Nagler, director of institutional Benelux at Schroders. “This is delaying the exit of companies, especially in the tech and venture sector.»
Anneka Treon of Van Lanschot Kempen warned of a “trickle-down effect” and wrote in the Financial Times to underline that investors should not see private equity as a way to escape the economic cycle.
Delayed effects
Nagler believes that more effects will become noticeable, albeit with a delay. He expects spreads will widen in the next six months and that there will be temporarily fewer takeovers because of the current gap between the price that sellers are still holding on to and the price that buyers are willing to pay based on the lower valuations.
In addition, Nagler said the effects will not be of the same order of magnitude as on public markets. Private markets are systematically cheaper, due to the lower liquidity. Certainly SME companies can be bought at a much lower price than larger listed companies. There is also the advantage that these companies often do not aim for an IPO when they exit.
He also noted effects in specific parts of the market, namely in venture capital, and said that these types of young companies are less likely to receive a loan because they often do not make a profit and sometimes do not yet have a product or service. With large-cap deals, these are typically companies that ultimately aim for an IPO and are therefore more dependent on the stock market climate.
“You can postpone an IPO for a while, hoping that the market will be better,” Nagler said. “But the question is then, how quickly can the market correct and to what extent must a company be forced to go to market? If the current market pressure continues, the valuation will have to come down.”
Large caps
Large caps are mainly held in portfolios of larger private equity funds. In Nagler’s experience, too much work would otherwise have to be done to fill a portfolio. The work involved for a 50 million deal takes just as long as a 2 billion deal, requiring the same due diligence and analysis. “So with a fund size of 10 billion plus, you have to go for big deals because you don’t have the manpower to do that many small deals.”
Advent International, a private equity investor with nearly 100 billion dollars under management worldwide, is an investor with such a large portfolio. The firm recently raised 25 billion dollars for the tenth version of its private equity fund that buys up companies in five different sectors. The money was collected within six months.
The investor invests, among other things, in carve-outs, in which it buys up discontinued business units. In addition, it concerns «p-to-p» investments and family owned companies. Head of Benelux Jurriaan van der Schee does not expect any problems in putting committed capital to work, not even when it comes to large caps.
Not least because, according to Van der Schee, prices have fallen now that listed companies are less active as buyers. “Their share prices have fallen and in difficult times they keep more money on their balance sheets. In addition, you see it immediately reflected in the price if a listed company now buys another company that does not immediately generate additional profits. We have more time to improve. And we do not have to present our results every quarter, like a listed company. We can look through the cycle.”
Too easy
But of course, said Van der Schee, also at Advent there is the realisation that the market has changed substantially because of the war in Ukraine, supply chain disruptions, continuing inflation and more expensive financing. But he thinks it is too easy to say that there are fewer opportunities as a result. “Within each sector there is an impact from the macro environment, but at the same time within each sector there are examples of interesting opportunities in that environment. There will always be trends that people continue to spend money on, even within a theme like e-commerce.”
Advent looks at micro, he emphasises: healthy companies with healthy growth prospects, where there is still potential to improve operations. Van der Schee: “Indeed, if I look back over forty years, we made some of our best investments in a time of crisis. That also creates opportunities, because valuations are adjusted. As a private capitalist, you can continue to invest, you can become stronger.”
Paradox
Nagler noted a paradox in this regard. For new investors who want to go private, this is actually a better time. They are investing at much lower valuations. It is rather difficult for the investors who started five, six, seven years ago and who now have to sell.
Can you arm yourself as an existing investor in private? Nagler: “That is of course the whole premise of private markets: they are illiquid. Ninety-five per cent is hold to maturity. You invest and you get out at the end.”
But for those who step in, he says that small- and mid-cap buyouts seem to be the safest building blocks. “They have the lowest risk and yet returns that are historically around 12 to 15 per cent.”
This article originally appeared in Dutch on InvestmentOfficer.nl.