2. Greater options for capital deployment
Due to the high cost of debt and the corresponding implied impact of higher interest rates on valuations, control leveraged buyouts of private companies are likely to be fewer than in the heyday of 2021. Still, this won’t shut down dealmaking. There are many other opportunities for PE firms to enhance their portfolios.
We expect take-private transactions to be a feature of the 2023 market as PE firms take advantage of stock market volatility and invest in public companies at a significant discount to their peak valuations. Taking a company private provides an avenue for PE firms to invest in strong players at mark-to-market valuations, while valuations of already-private companies have not adjusted to the new market reality.
Another capital deployment and return strategy we expect to accelerate is sponsor-to sponsor minority sales. These deals don't require financing or trip change of control provisions. Selling minority stakes also allows sponsors to demonstrate to LPs that they are generating value by achieving a higher price than when the asset was acquired, but still retaining the upside of future value appreciation.
There will also be growing interest for PE buyers in corporate carve-outs as public valuations drop and management teams look to streamline their assets, shore up their balance sheets and ‘unleash value’4.
And finally, while the economic climate is likely to increase pressure on many portfolio companies, we don’t expect this pressure to lead to a surge in distressed credits. Covenant-lite capital structures will provide sponsors more time and flexibility to address performance. Instead of distressed deals, we expect to see more opportunities for preferred/structured equity transactions. This ‘reinforcement capital’ will be received by some financial sponsors and be provided by others. At the same time, it will shore up portfolio company balance sheets while allowing existing owners to avoid having to inject new equity into old investments. Just recently, Macquarie Capital provided $US62.5 million of preferred equity to Future Fiber (doing business as GoNetSpeed), a rapidly growing fibre-to-home platform backed by Oak Hill Capital. Macquarie Capital’s investment represents 50 per cent of a $US125 million total investments, with the remaining 50 per cent provided by Ares Management.
Why it matters
The disconnect between sellers looking for 2021 prices versus buyers seeking perceived lower 2023 valuations has created a period of inertia, forcing financial sponsors, in the short term, to find creative ways to deploy and return capital. As sellers realise that holding out for 2021 valuations is not a viable long-term strategy, we expect to see a marked increase in deal activity in the second half of 2023.
This increase in deal activity should be felt across all markets, and be even more noticeable in key industry sectors such as software & services and healthcare. Software, for example, has demonstrated impressive resilience through market volatility. Healthcare, too, has proven to be a dynamic investment segment for the PE community as technology, regulation and an aging global population have all driven dramatic change and corresponding investment opportunities. Macquarie Capital continues to expand its coverage in these areas, adding experienced Managing Directors to its Software & Services and Healthcare teams to support this expected increase in deal activity.