The global coronavirus pandemic has ground economies around the world to a halt — and the slowdown is having a major impact on private equity exits, according to a new report from global consulting firm McKinsey & Co.
“With a couple of exceptions — such as structured transactions and deals signed before the crisis — traditional PE exits have slowed significantly since mid-March of this year,” wrote McKinsey partners Alastair Green, Ari Oxman, and Laurens Seghers in the report. “Announced PE exits dropped almost 70 percent globally in May 2020 versus May 2019.”
Several factors have contributed to the slowdown, according to the authors, who interviewed more than 40 sponsors, investment bankers, and CEOs from March to May, mostly based in Europe and the United States. Valuations have suddenly shifted, with businesses facing tanking demand as a result of the crisis — which has also laid bare new weaknesses in many portfolio companies.
The crisis has also thrown up major barriers to deal execution, preventing face-to-face due diligence meetings and increasing financing costs. Finally, firms have placed exits on the back burner as they focus on business disruptions and health and humanitarian concerns, the report said.
The survey participants said they think exits via traditional leveraged buyouts will be tough for at least the next four to six months — and many are spending “far more time than normal” on preparing for exits.
“Hundreds of sponsor-backed companies preparing for imminent exit now find themselves in a waiting state: unable to exit but with additional time to prepare,” the report’s authors wrote.
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Both companies and sponsors are making creative use of that time, according to McKinsey, which observed “four major tactics” CEOs and sponsors are pursuing to make the most of their exit preparations.
One is simply to invest in growth areas, with McKinsey observing many companies opening new business models to stay relevant in “the next normal.” Another is to create more value, whether by re-negotiating third-party spending, cross-selling, or by demonstrating their potential to create value to buyers. For example, a portfolio company active in manufacturing introduced natural-language processing to extract key terms from its contracts quickly and accurately to help monitor contract expiration dates, which helped to save time and resources.
A third tactic McKinsey is observing is more drastic: making “hard pivots” to stronger, more resilient business models, such as an infrastructure-services company that shifted toward recurring revenues tied to operations and maintenance services. Finally, companies are “fundamentally rethinking their strategies and building them around clear-eyed visions of the future,” according to the McKinsey partners, who cited a media services company that began looking for M&A targets to acquire as a means of getting into new markets.
“Smart companies and their sponsors — probably in touch with their investment bankers — should invest the time to understand which strategies can help create value and then begin planning accordingly,” the authors concluded.