Private equity managers knew that 2023 was going to be brutal. Rising interest rates were causing valuations to plummet and fundraising was getting more difficult. But tempered inflation and the possibility of the Federal Reserve cutting its benchmark interest rate this year has PE firms more upbeat.
“While by all accounts the industry has adjusted to this new normal, there are signs that the clouds are parting,” lawyers at Debevoise & Plimpton said in the firm’s latest quarterly private equity report.
Investors are broadly maintaining (or boosting in the case of family offices) their allocations to alternative investments. In a February 19 note about the alternative asset management sector, sell-side analysts at Citi said they see room for improvement in 2024.
“[P]rogress on increasing penetration of the [private wealth] channel will be a continued focus and we expect to see increased traction here given new product rollouts for a number of companies and efforts in sales, marketing [and] education,” the Citi note said.
Executives at companies owned by private equity firms agree that 2024 is shaping up to be much better than last year. But they don’t appear to be seeing eye-to-eye on what that will mean for deal activity.
Portfolio companies have suffered in recent years and there could be more middle-market pain to come. Their revenue fell 24 percent in 2022 and 7 percent in 2023. Profitability fell 11 percent and 26 percent, respectively, those same years, according to a BDO survey of chief financial officers at 142 U.S. middle-market companies. The executives were surveyed late last year and their company revenues ranged from $250 million to more than $3 billion.
Far fewer PE-backed companies expect year-over-year performance to worsen in 2024. Inflation is slowing down, material and labor costs are moderating, and supply chain disruptions are less frequent or improving. As a result, only 3 percent anticipate revenue will decrease and 8 percent that profits will fall, according to BDO.
Just 4 percent of CFOs have plans to file for an initial public offering in 2024, down from 14 percent last year. Portfolio companies with plans for enterprise sales have also fallen significantly to 31 percent, down from 49 percent last year.
For years, a rising equity market helped raise all valuations. During the past couple years, private equity firms have focused harder on improving their portfolio companies they own to make them worth more and companies have bought into that. Many more companies have product or service expansion plans in 2024 (37 percent) than they did in 2023 (21 percent). One potential speed bump to any product and service expansion is an ongoing talent shortage. More than half of company finance heads told BDO the crunch was a risk to achieving their goals.
If their companies can overcome that challenge and markets keep trending in a positive direction, 2024 could be the year that stakeholders are hoping for.
It’s also worth noting that market sentiment has generally improved since the BDO survey was conducted.
“Private market valuations lag public market indicators. With 2023 ending on a high note for the public markets, we’ve started to see some improvements in portco valuations,” Patrick Donoghue, corporate finance and transaction advisory leader at BDO, said in the report.” If these trends continue, we expect add-on acquisitions, recapitalizations and portco exits to drive PE deal activity in 2024.”
