The private equity industry is navigating a challenging landscape in 2024, marked by higher interest rates, inflationary pressures, and geopolitical uncertainties. Despite these hurdles, the sector shows resilience, with emerging opportunities for growth and investment.
The global economy is beginning to recover after years of pandemic-induced disruptions and ongoing geopolitical conflicts, notably the war in Ukraine and the Israel-Gaza conflict. These factors have led to fluctuating energy prices and supply chain disruptions. However, inflation rates have started to recede, paving the way for anticipated interest rate cuts later this year.
Major economies, including the United States, the Eurozone, and the United Kingdom, are expected to see cautious rate cuts as central banks strive to balance inflation control with economic growth. This anticipated turn in the rate cycle is likely to foster stronger economic momentum, creating a more favorable environment for private equity investments.
Despite the positive outlook for interest rates, the private equity sector faces several challenges. High borrowing costs and reduced liquidity have slowed deal-making and fundraising activities. According to Bain & Company’s analysis, global buyout deal value declined by 58.0% year-on-year in H1’2023, while private capital fundraising dropped by over a third.
Private equity firms are adopting pragmatic strategies to navigate these headwinds. Many expect longer fundraising periods and tougher deal conditions. Nonetheless, the industry’s core model remains robust, with high-quality assets still attracting fierce competition and enabling successful exits.
The Argos Index indicates that EBITDA multiples for mid-market deals in Europe have seen a correction. The average EBITDA multiple was 9.1x in Q3’2023, down from a peak of 11.6x in Q2’2021, and below the five-year average of 10.2x. This decline reflects a more cautious and realistic approach to asset valuation amid broader economic challenges and higher borrowing costs.
Pete Wilson of IK Partners notes that the days of buying businesses at low prices, doing little, and selling high are over. The focus has shifted to precise value creation plans and thoughtful consideration of future buyers. This strategic approach requires private equity firms to meticulously create value, ensuring they are not solely dependent on favorable market conditions for exits.
General Partners (GPs) have adopted a conservative stance on valuing portfolio companies. Data shows that a significant proportion of buyout exits from 2012 to Q3’2022 proceeded at higher prices than previous valuations, highlighting a cautious yet effective approach. There is a notable split in pricing between high-quality assets and others. For high-quality companies, intense competition remains, and the possibility of achieving higher valuations, similar to those in 2021, exists even with reduced leverage.
The private equity industry’s ability to adapt to these evolving conditions underscores its resilience and potential for continued success. By focusing on strategic value creation and maintaining a cautious approach to valuations, private equity firms can navigate the current economic landscape and capitalize on emerging opportunities.
