Private Equity Firms Won’t Waste Another Crisis

“We think they’ll be more aggressive this time around,” EY predicts.

Illustration by II

Illustration by II

Private equity firms won’t waste another crisis, EY predicts.

If the pandemic pushes the economy into a recession, investment companies will put money to work a lot faster than they did during the last major downturn in 2008, according to a report published Wednesday by the consulting giant.

The study argued, among other things, that private equity firms will quickly make investments in struggling companies and vacuum up assets if hedge funds, mutual funds and other traditional managers are forced to sell. It’s not hard to see why.

Funds started in 2006, around the pre-recession market peak, returned a median 8.1 percent, while those with a 2009 vintage delivered 13.9 percent.

“The global financial crisis was the first real test of the private equity model. Could they refinance their existing portfolios, not to mention do new deals?” said Peter Witte, EY’s global lead private equity analyst, in an interview with Institutional Investor. “There were concerns at the time. But we saw that PE-backed companies ultimately suffered fewer defaults and invested more [in their businesses] than companies not backed by PE.”

Private equity portfolio companies often have stronger relationships with banks and other lenders than the average corporation, Witte explained. In addition, private equity firms were hyper-focused on the survival of their portfolio companies, including taking market share from struggling competitors, during the financial crisis.

“But one of the missed opportunities was that they weren’t aggressive enough in deploying new capital when firms hit bottom. We think they’ll be more aggressive this time around,” Witte told II. According to the study, “many PE firms recognize that the GFC represented one of the best buying opportunities of all time and that both GPs and LPs were overly cautious.”

Private equity firms have a lot more money to work with than last time. All PE funds, including credit and growth capital, have amassed an estimated $1.4 trillion war chest, ready for immediate deployment. Private credit funds, including distressed, direct lending, and special situations, have grown into an $800 billion industry. “That money can be deployed to support firms in ways that weren’t available before,” he said.

As other asset managers, including hedge funds, are forced to sell holdings in a troubled economy, EY expects private equity firms to be big acquirers. This could result in more take-privates — public companies being converted to private firms.

“We’ve seen that trend in the market for the last several years. With a lot of volatility on the public markets side, there is an opportunity for PE firms to come in and get high-quality companies at attractive valuations. Over the last few years, we have seen a convergence between private and public market multiples,” Witte said.

[II Deep Dive: How Private Equity Became a Beta Play]

EY argued that private equity-backed companies also benefit from business experts and operating partners that their investors have fostered over the decades. In 2008, generally only the larger firms had operating expertise. Now, most portfolio companies can get help with supply chain issues and other day-to-day challenges.

Still, the private equity model of restructuring companies isn’t always pretty. Layoffs, severance pay, selling unprofitable groups, and other measures designed to make a company more efficient can generate a lot of ill will — especially during a recession.

“Should a downturn occur, it is highly likely that such scrutiny may increase, as PE firms work to usher their companies through disruptive headwinds, often having to make difficult decisions in the process,” EY cautioned in the report.