S&P Global — 23 July 2024
Daily Update: July 23, 2024
Private Equity Shows Signs of Friskiness
By Nathan Hunt
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For a time, it seemed that private equity was shrinking into obscurity, with deal size contracting, exits dragging out and M&A activity slowing to a trickle. Meanwhile, exits continued to be far slower in the second quarter than they were in 2022. But there are promising signs that the private equity slowdown may have bottomed out. This doesn’t mean that valuations have bounced back or that most funds are generating outsized returns. Private equity returns have become more of a grind. But a combination of improved macroeconomic factors, an abundance of dry powder and diminished expectations are pointing to a gradual recovery.
Everything starts with inflation. As central banks raised interest rates to combat inflation, the cost of capital mounted for private equity deals, and many potential deal partners held back. With inflation nearing central bank targets, investors are anticipating lower interest rates in the second half. For firms and funds with dry powder, this could create some urgency to get deals done before cheaper capital can increase the price of an acquisition. Dry powder is defined as capital that has been committed to, but not yet invested in, a fund. In the last three years, dry powder has ballooned in private equity.
There are still reasons for companies and private equity firms to hesitate on deals, such as persistent geopolitical uncertainty and the upcoming presidential election. The total global private equity exit value slowed to its lowest level in five years in the first half. The average age of portfolio company investments stretched out to 5.7 years, and funds are having to develop portfolio companies more to achieve a positive exit.
"The days of financial engineering — buy low, sell high — are long gone,” said Paul Aversano, a managing director at M&A adviser Alvarez & Marsal. “Now, all these private equity firms have to actually do things to create value in the portfolio. That takes time."
On the bright side, the IPO window appears to be reopening for private equity-owned portfolio companies. Private equity-backed IPOs topped $10 billion during the first and second quarters. It’s been more than two years since IPOs broke this threshold, according to Preqin data. In another positive sign for dealmaking, the number of private equity-backed deals that were terminated before completion fell 86.2% year over year in the second quarter.
Global private equity deal value also jumped in the second quarter, reaching $175.73 billion from $123.65 billion in the same period a year ago. Second-quarter pension fund-backed deals increased as well. Pension funds can be both investors in and deal counterparties to private equity firms. Some market participants believe that the jump in deal value can be attributed to dry powder finally being brought to market.
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