In a relatively short time, we’ve all become very accustomed to disruption. Since the middle of the last decade the world seems more volatile and unpredictable. Where historically the new year has been a time for renewal and optimism, it seems we’re starting 2023 by asking ‘how bad is it going to be?’
For the last four years AlixPartners has surveyed 3,000 global executives to seek their views on disruption. As a reference for the year ahead it is invaluable and this year, amongst the many challenges facing those surveyed, there is cause for optimism…
A group of growth leaders is emerging – businesses and leaders who have not just become accustomed to disruption but are beginning to thrive, driven by a bias to action, operational agility, and an appetite to invest.
With this in mind, using this data as my basis, I started my year by talking to some of my private equity clients. Not to ask them ‘how bad is it going to be?’ but to get their views of how the year might pan out – good, bad, or otherwise. Here are the key takeaways:
- Underlying consumer demand will continue to weaken in Q1. This may be felt particularly strongly in Europe and particularly the UK, with the US and Asia (via China re-opening) better positioned to navigate the environment. In the UK, the reporting cycles in March and April will likely give us an indication as to whether we are at the bottom of the market, but given the leverage and interconnectivity in the system, there is still likely to be broader global impact. This will affect the valuation and longer-term viability of certain assets and PE will need to act to preserve value across their portfolio. Likewise, this will likely lead to opportunities for other funds such as credit or distressed investors in the short to medium term.
- Private Equity and credit can anticipate a year of transition. My colleague Sean and I wrote about the end of ‘easy M&A’ late last year. We’re beginning to see this manifest itself in many ways. Buyers and sellers are exploring ways to tighten up the bid-ask spread on value that exists today. Balanced against that, the clock is ticking on both capital deployment and realisation needs for GPs and LPs. Those investment theses need to really stack up and we can expect deep due diligence to become common, if not non-negotiable, particularly given the likelihood for tighter covenant packages.
- Expect the leverage finance market to return to health over the course of the year. While the market has moved back to the lenders, we would expect balance sheets to be unlocked in the second half of the year. So, it’s not all bad news! We’ll see some newly structured buyout financings (higher cost, less leverage), capital structure optimisation and restructuring of existing credits (such as through equity infusions) and continued growth in private credit solutions.
- Much of the dry powder remains unburned – this will drive transaction activity globally. Having now reached almost mythical status, the legendary piles of cash in Private Equity will increasingly be deployed this year, and we would expect dealflow to be significant in 2024. Driven by a series of ongoing trends – digitisation, inflation, demographics, sustainability, and energy security – PE will make deals that capitalise on or address these factors.
- More bilateral and minority deals. No one wants to sell at a low point, but we will see owners looking to reduce risk and take capital off the table where they can. We can expect smaller, bilateral deals to increase, particularly if that investment brings with it genuine expertise and ability to generate value in down markets. Overall, it is likely that we will see valuations begin to align with historical norms.
- It will feel like a game of two halves. H1 will be portfolio company/secondary-driven (equity recaps and primary capital). H2 will be a better mix of primaries (take-privates and corporate carve-outs). The result of all this is what should be an improving LBO calendar in 2023 and record-breaking volumes for 2024.
No sector is untouched by disruption. PE is a powerful and effective driver of growth but, like so many industries, it too is having to ask itself some difficult questions. LPs will need to make difficult choices about which GPs they want to back next year. As returns fall, we can expect more difficult questions about the way private equity firms are run and the extent to which they can really drive value creation.
The industry has learned some hard lessons since 2020 and while dealmaking may not be easy, those that move with pace and discipline will emerge primed to capitalise on what promises to be a big 2024.