The Impact of Coronavirus on the Private Equity Market
As the stock market partially bounced back from the sharp decline in mid-March, alternative investments that are more long-term focused, such as private equity, are still showing a clear downward trend. On a broader scale, in the first quarter of 2020, in the private equity market, both deal volume and transaction value were down. Most notably, deal volume decreased drastically by 21.68% from last year. Some PE giants also halted their acquisitions by the end of March. Even KKR put its original plan of selling Goodpack on pause. Goodpack is a Singapore-based bulk container maker which was expected to be sold for at least $2 billion USD. Given these shocking statistics, this article attempts to dive deeper into different challenges PE firms are currently facing due to COVID-19.
First of all, the pandemic is hitting various types of PE funds differently. It is almost a no-brainer that PE firms with a majority of their portfolio companies in the retail, tourism, and oil industries are struggling to support these companies they own. The nature of private equity also worsens the challenges their portfolio companies are facing. According to PwC, since the PE firms aim to sell their portfolio companies eventually, these companies “may have less robust contingency plans for dealing with this type of emergency.” Additionally, the way a PE firm funds its deals also impacts the extent to which the firms are affected by the pandemic. The PE funds that normally use higher leverage would have to fight harder to stay solvent as the cash flow from their portfolio companies dwindles. With the low level of cash flow, the debt burden would weigh heavier on their shoulders and add additional stress to the fund. On the contrary, portfolio companies that are mostly in the software, technology, and healthcare space that are owned by growth equity investors would be relatively safe. As some software companies keep bringing recurring revenue, enabling people to work from home, and generating a higher EBITDA margin, they are more likely to be able to weather this pandemic. Therefore, different types of PE funds with different financing and investing strategies and goals would face different challenges at this time.
Secondly, besides operational challenges, completing a transaction could become harder for many reasons involving valuation, financing, and due diligence. For the valuation part, it’s harder to forecast future profits due to the current uncertainty. The trending joke “EBITDAC”--- “Earnings Before Interest, Tax, Depreciation, Amortization, and COVID” is becoming less of a joke but the new reality. In terms of financing deals, according to Mintz,“ lending availability will be more limited and this will require alternative approaches to the financing.” As debt financing becomes a less viable option, other financing strategies such as equity and earn-outs would become more common. Lastly, conducting in-person due diligence becomes more laborious and risky in the lock-down. Therefore, acquirers would need to find alternative ways to negotiate deals and conduct due diligence virtually. Lastly, as firms focus more on keeping portfolio companies alive rather than completing new transactions, we expect that it would take longer to close a deal. It’s reasonable to speculate that there could be more opportunities for distressed investing in the next two quarters.
In conclusion, the above-mentioned risks are only my personal opinions and they are not exhaustive. In such a turbulent time, each firm needs to assess its own portfolio companies and investment strategies to find the best way to mitigate risks.
Resources:
Rosacia, Pam, and Gaurang Dholakia. “Pandemic, Economic Uncertainty Slow US Private Equity Deal Activity in Q1.” Pandemic, Economic Uncertainty Slow US Private Equity Deal Activity in Q1 | S&P Global Market Intelligence, 9 Apr. 2020, www.spglobal.com/marketintelligence/en/news-insights/latest-news-headlines/pandemic-economic-uncertainty-slow-us-private-equity-deal-activity-in-q1-57949952.
Daga, Anshuman. “Exclusive: KKR Shelves $2 Billion Sale of Singapore-Based Goodpack Due to Market Slump: Sources.” Reuters, Thomson Reuters, 1 Apr. 2020, www.reuters.com/article/us-health-coronavirus-goodpack-exclusive/exclusive-kkr-shelves-2-billion-sale-of-singapore-based-goodpack-due-to-market-slump-sources-idUSKBN21J480.
PricewaterhouseCoopers. “COVID-19 and the Private Equity Industry.” PwC, www.pwc.com/us/en/library/covid-19/coronavirus-private-equity.html.
“Private Equity Investing and the Pandemic.” Mintz, www.mintz.com/insights-center/events/2020/private-equity-investing-and-pandemic.
