Has private equity reached a crosswords?
THE economic downturn has most certainly impacted transaction activity in the North East, with a reduction in the number of deals coming to market.
While the number of deals has dropped considerably, we are starting to see some well-funded corporate buyers pursuing opportunities.
Private equity investors are finding the current market conditions less favourable. With cheap, easy credit no longer available the traditional private equity model based on high leverage and financial engineering is no longer viable. However, private equity can still play an important role in helping portfolio companies survive and thrive in this harsher financial and economic environment.
In this significantly changed environment, cost control and efficiencies have become paramount. The private equity model based on achieving operational improvements therefore has an important role to play in returning the economy to sustainable growth.
Many private equity-backed companies have had to cope with not just the economic downturn, but also the added burden of highly leveraged debt structures. So what issues are private equity backed companies facing at the moment?
The lack of available funds has led to a focus on organic growth, through new products or services or geographical diversification.
Private equity houses, in general, have done a good job in encouraging management to reduce costs, but portfolio companies now need to assess whether all practical steps have been taken to achieve efficiency gains. Stock control, creditor control and cash management are obvious areas for scrutiny and advisers can play a role in identifying potential efficiencies.
High leverage has led to minimal covenant headroom and managements are spending a greater proportion of time managing cash and costs. Good quality business planning is paramount. Companies should model realistic scenarios and where a potential covenant breach is anticipated, should talk to lenders sooner rather than later. This will allow management to maintain greater control and gives the lender time to commission due diligence should they wish to do so and take proposals through credit committees in good time prior to the default event.
Exit strategies too are changing, with many exit plans having been put back two or three years. The difficulty for private equity houses is that if exit slip from five to eight years, value in the portfolio company must be increased dramatically to generate the internal rate of return that private equity requires.
Many private equity backed companies now see secondary or tertiary deals less likely. In future, trade sales are likely to make up the majority of exits although IPOs remain an additional alternative for larger companies, given that the IPO market tends to recover ahead of the M&A market after a downturn. PwC are certainly seeing a large number of prospective IPO’s with an upturn in appetite from institutional investors.
The private equity market overall is likely to shrink, with lower quartile funds unable to raise new funds. Future deals are likely to be more conservatively leveraged with less focus on financial engineering and private equity returns more based on operational improvements.
:: Mark Webster is a partner, transaction services, PricewaterhouseCoopers, Newcastle. Call 0191 269 4011 or email: mark.webster@uk.pwc.com
