As reported in our annual global Turnaround and Transformation survey of over 500 industry experts, we expect that many of the businesses that received COVID-related financial help in 2020 will be in distress again this year. In fact, almost a third of global restructuring experts said that more than half of their clients that needed financing during the pandemic in 2020 would find themselves in financial distress again. This is quite remarkable and likely to lead to a wave of restructurings not seen since the Global Financial Crisis.
As our AlixPartners Disruption Index reveals this year, the magnitude and frequency of disruptive forces - aside from the pandemic - will only continue to increase, placing additional pressure upon organisations already facing severe liquidity constraints. As the support provided to businesses begins to taper and this additional debt has to be repaid, we’re then likely to see the winners and, unfortunately, the losers.
To date though, the tsunami of expected restructurings has not manifested. In fact, owing to the trillions injected by central banks, bans on commercial rent evictions, COVID loans and furlough schemes. we’ve actually seen very little. In addition, plenty of financing has been available, making debt refinancing possible despite the persistent economic uncertainty. This additional liquidity clouds the true performance of companies, making it difficult to determine whether or not they are truly viable in the post-pandemic world.
What does this mean for private equity funds?
We have analysed 938 PE funds with a vintage year between 2010 and 2018 to determine the prevalence of underperforming funds worldwide. We found that 281 of those funds are underperforming (with a net IRR of less than 10%). This amounts to $471bn of AUM globally. But owing to the availability of timely data, this likely underestimates the true impact of the pandemic and the performance of funds.
How will they respond? A likely response is for General Partners to ask for investment period or fund life extensions. The success of such a request is likely to rely on investors’ expectations of the recovery to pre-COVID levels and whether they have confidence in the existing GP management team to deliver sufficient returns.
In our recent article (Is a lack of homework creating parallels between the M&A and Housing markets in the UK?), we commented that deal flow in the world of Private Equity is going through the roof. Pre-pandemic, the amount of dry powder was valued at over a trillion dollars. While some of this has been used to shore up portfolios and weather the COVID storm, there is still significant capital to deploy. Add to that the low cost of borrowing, then a sharp increase in deal activity was going to be inevitable.
But there is a lingering concern. Is the combination of a seller’s market and a voracious appetite to do deals and secure assets on the PE side leading to uncharacteristically hasty deal execution? And, if so, what are the consequences? And in this context, how do poor investment decisions impact investors and the course of action they take going forward?
The next year or two are likely to be interesting for PE funds as they navigate the complexities of the current market. How far are investors prepared to go to ensure returns are in line with their expectations? How will GPs respond to the growing demands placed upon them? Only time will tell.