Following a period of unprecedented activity from late 2020 through mid 2022, private equity (PE) activity slowed markedly in the second half of 2022, reflecting uncertainty and disruption driven by inflation, rising interest rates, shuttered debt markets and geopolitical turmoil. Over this period, PE deal volume declined by 22% versus 12 months earlier and has now broadly returned to pre-COVID levels.
With record levels of dry powder (US PE holds $1.1 trillion), we expect more creative approaches to deploy capital (minority investments, all-equity deals, private placement of debt) and a broader recovery in activity either as inflation is tamed or asset valuations are sufficiently depressed.
Despite this, the near-term investing climate will continue to test this generation of PE firms. Winners are likely to be those most able to adapt in response to both acute conditions and longer term trends, with critical topics including talent, digital and ESG likely to continue their rise up investment committee agendas.
PE is sitting on a record level of dry powder and retail investors are becoming an emerging funding source at a time of constrained deal activity. As a result, we expect significant near-term changes in which deals are done and how they are done.
Which deals will get done? A major theme will be public-to-private deals and carve-outs as market valuations continue to drop and corporates look to streamline their portfolios. We also expect to see continued focus on diversification from traditional PE to other asset classes spanning credit, infrastructure, real estate, impact and others — with potential for some investors to incorporate multiple investment strategies on a single deal. Traditional LBOs will continue — particularly in the middle market — though we expect their dominance to wane.
How will deals get done? We’re already seeing novel strategies to deploy capital despite the financing crunch. Examples include minority deals (typically not requiring refinancing), all-equity deals (which avoid the debt issue entirely) and private placement of debt (to bypass the more challenging syndicated markets). These strategies will support continued capital deployment as funds await more general market normalization.
Notwithstanding these tactics, some of the current market disruptions will likely persist and may herald a broader shift into a more challenging value-creation environment. Emerging with a (renewed) concentration on critical value creation drivers — including digital, talent and ESG — will be vital to long-term success.
PwC’s upcoming divestitures study found that most companies are reluctant divestors. This attitude permeates most industries and creates a stigma that can lead to a lack of timely divestitures.
But the current economic environment is creating an opportunity for companies to take advantage of the value creation opportunities offered by divestitures. Corporates, both public and private, and private equity portcos are looking to trim underperforming businesses and raise cash to alleviate pressure from higher-interest debt and the resulting impact on share prices. Meanwhile, higher sustained interest rates are also finally lowering valuations that have become frothy over the last two years.
The confluence of these market forces sets up a unique opportunity in 2023 for public-to-private and corporate-to-PE transactions, whether full acquisitions or partial carve-outs. These opportunities are likely to transact at discounted to distressed prices, elevating the long-term expected returns of such assets. We expect this buyer’s market to particularly benefit private equity funds, which will likely put their dry powder to work.
“We're in a period of intense change for PE, reflecting the acute economic environment and longer-term evolution. Success requires both navigating near-term uncertainty and positioning for future differentiation through talent, digital and ESG.”