This article is written by Vinayak Bajaj, from Amity University Mumbai, Maharashtra and the article is edited by Khushi Sharma (Trainee Associate, Blog iPleaders).
It has been published by Rachit Garg.
Private Equity investment has seen an unprecedented amount of deal activity in 2021, which is two and half times the volume in the previous year and double of the prior record highs. With billions of dollars at their disposal, buyout firms have already taken advantage of a record year for mergers and acquisitions by selling some of their holdings for top pay. According to the data, we might not see this level of deal activity happening again moving into 2022, but at the same time there’s nothing fundamentally or structurally wrong with the market that would cause it to slow down. Private equity companies have plenty of dry powder on hand, and a large amount of investor money is flowing into private equity funds, ready to be deployed in new transactions.
It is critical to understand where we’ve been this year in order to know where we might be in 2022. With this in mind, the author has provided an assessment of private equity activity in the current year as well as the way forward approach to it.
Covid has forced businesses to reinvent themselves. Given, the large amount of dry powder available with private equity firms, we can expect a lot of capital being invested as growth capital as companies are looking to improve their functioning after surviving the pandemic at least in the first quarter of 2022.
Another issue that has been causing substantial concern as of a week ago is the omicron variant that has recently invaded India.
Due to the omicron uncertainty, company growth, GDP and other financial indicators may be dampened in the first half of 2022. Vaccination rates have increased and according to several reports a new omicron vaccine is currently being developed which will be ready for supply in the next three months.
There are several challenges in the supply chain of portfolio companies which is likely to effect EBITDA. Raw materials and other products are held up through international shipping bottlenecks due to quarantine mandates and the costs associated with shipping is extremely high which is making it difficult for companies to navigate these elevated expenses to their customers. The supply chain strain is likely to continue in the first half of 2022. Overall, many India-based PE fund portfolios have proven to be highly resilient, and funds are focused on efforts to stay ahead of the curve.
Given the data, private equity deal activity in 2021 was at a record high with estimated deal value at 787.6 billion US dollars. Although the deal count has reduced as compared to the last year, the investment volume has substantially increased over the years. Moving into 2022, private equity investments are likely to increase as firms are sitting with large amount of dry powder because of the pandemic. According to reports, private equity funds have around 1.5 trillion US dollars of dry powder and the funds waiting for the companies to show positive financials for the past two years will be entering into new transactions.
There has been a drop in the number of firms raising funds in the past two years but the fundraising amount has almost stayed intact. This points out the fact that a few firms are launching massive funds and receiving high amounts which is only going to increase the deal activity entering 2022.
Liabilities, cyber security threats, inadequate financials and similar issues could be the biggest roadblocks to a deal closing in the first half of 2022. Increased competition from other investors, as well as a disparity in buyer and seller valuation expectations, might prove to be a possible hurdle.
Each deal stage in private equity has its own set of hurdles. However, the exiting stage is likely the most difficult, particularly during times of economic uncertainty. There are numerous elements to examine, ranging from the overall performance of the market and potential regulatory or legislative influences on that performance to more deal-specific issues like valuation multiples and financing availability, among others.
Private equity firms have made exits from portfolio companies at record levels in 2021 amounting to around 630 billion US dollars. The main reason for this astronomical climb is inflation. According to reports, the US inflation is at 6.8, which is its 40year high level. These inflated prices have pushed private equity firms to exit their investments and realize their profits as investors are looking for yields. In the coming year, if the inflation continues to sustain these levels, the government will be forced to increase interest rates in the second half which is the only solution to bring down the inflation. This might also affect the private equity investment activity.
Though typical holding period has lengthened, the likelihood that deal activity will stay high through 2022 suggests that a range of vintages may benefit from the overall market’s success.
Digitization of all industries is creating opportunities for tech enabled services businesses, software companies and technology industry in general. There has been a surge in IT industry deal activity due to the COVID pandemic in the past couple of years. Consumer technology and IT & ITES were the two largest sectors in absolute terms in 2020-2021. In 2021, compared to the past year, there has been a rise in deal activity in consumer products and services rather than business pro-duct services as the B2C market is constantly growing and we don’t just live in a B2B market anymore.
Furthermore, businesses that are more cyclical and project based, and have been hit by COVID are expected to post strong performance. As we move away from COVID one month at a time, these businesses are reverting to their pre-COVID levels.
Deal activity in the healthcare sector is nearing its pre-covid levels as we are moving away from COVID. However, the scare of new variants popping up can increase deal activity in the healthcare space as this is a pandemic resilient sector.
From an investment perspective, investors also expect increasing interest in digitally accelerated opportunities such as digital health, fintech and ed-tech.
Environmental, social, and governance (ESG) issues are becoming more widely recognized as value drivers. Private Equity Firms are considering ESG while making investments as a result of which ESG policies and the performance of target organizations and industries have been scrutinized more closely.
In light of their possible enhanced visibility to the public and investors, large and mid-sized businesses may feel more pressure to integrate ESG goals, as well as increased requests for ESG action and corporate transparency. The main challenge for major fund managers was guaranteeing the integrity of data and systems for ESG reporting, followed by implementing ESG enhancements and detecting and mitigating material ESG risks. We can expect additional issues surrounding standardization and reporting to emerge as fund managers figure out how to include ESG criteria into their strategies moving into 2022.
There is no specific Special Purpose Acquisition Company (SPAC) laws in India, but there has been a magnificent boom in the US SPAC IPOs in the first quarter of 2021. US SPAC IPOs have recorded around 21 billion US dollars of activity in the first quarter but there has been a massive drop from the record highs to around 6 billion US dollars in the next two quarters combined. This fall was caused due to certain regulatory issues regarding SPACs in the US.
However, in 2022 we can expect the SPAC IPOs deal volume to rise from its lower levels since there are no known issues currently in this market. We can also expect a number of Indian companies being acquired through these special purpose acquisition companies. It will continue to be around but the pace of new issuances is unlikely to match the first quarter of 2021.
The COVID-19 pandemic and its ramifications are clouding the economic landscape, making predicting and policy decisions extremely difficult. As certain industries – hospitality, retail, energy and healthcare experienced increasing disruption and loss, fund managers with industry know-how and adroitness in producing value were able to negotiate agreements that complement or amplify their portfolios, resulting in more investment opportunities. Many businesses that have been exploring a sale pre-covid and have been on the sidelines for the past two years due to the pandemic could be entering the markets in the coming year as their financials have now recovered. The valuation multiples of the companies are pretty high but the amount of due diligence done by private equity groups to validate and substantiate what they are going to pay for the company is also very high. Fund managers are looking to creatively manage cash flow across the portfolio to unlock cash from working capital throughout the holding period.
Furthermore, data breaches are at all time high and have recently posed a threat to business performance. It is critical for private equity firms to have a cyber security assessment of their portfolio companies. This is just an analysis of the trends in the private equity landscape according to the past and present scenario of the markets all over the world. Nobody has a crystal ball as to what changes might happen in this area of investment especially due to the uncertainty caused by the omicron variant as we step into 2022. While competition will remain severe for the foreseeable future, the asset class as a whole will continue to improve its value creation and exit strategies in order to generate the kinds of returns that LP’s will seek.
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