As global economic activity grinds to a halt and businesses all over face massive losses in the midst of the coronavirus outbreak, investors are scrambling to re-evaluate their portfolios and exposure to public and private markets.
For many fund managers, the current priorities are ensuring the safety of their employees and those of their portfolio companies, as well as the viability and liquidity of these businesses.
However, some private equity funds could see emerging opportunities for acquisitions once the market volatility settles.
According to a report from alternative asset industry research firm Preqin, private equity funds raised in 2018 and 2019 are well-placed to acquire assets at attractive valuations at the bottom of the pricing curve. These funds were earlier expected to struggle amid high asset prices and competition but could now see higher returns compared with vehicles raised and deployed a few years earlier.
In Asia, PE funds closed in 2018 and 2019 include PAG Asia Capital ($6 billion), Bain Capital ($4.65 billion), Warburg Pincus ($4.25 billion for China and Southeast Asia) and EQT ($800 million). In total, there is still nearly $400 billion in dry powder waiting to be deployed in the region.
“While a recession does pose material risks to portfolio companies and exits today, it also represents a record opportunity for fund managers to buy at low prices after the longest bull market in history. And this does in fact, bring meaningful opportunity for recent vintage funds,” said Preqin analyst Chia Jie Sin in a recent webinar.
In addition, investors are now in a significantly better position to negotiate asset valuations, and importantly, the vision for the company and the execution of that vision, says one private equity player.
“The new capital providers will be in a position to negotiate stronger rights with the company. They will be in the drivers’ seat,” said Atim Kabra, founding partner of Frontline Strategy.
Further, funds being raised in 2020 could see a better ride. “If the past crisis is an indicator of things to come, we found that the returns of private equity funds raised right before the GFC was lower by three percentage points versus those that were raised right after the GFC,” Preqin analyst Kam Ee Fai noted in a recent presentation.
Among the funds that have closed this year is CVC Capital Partners’ fifth Asia Pacific fund at $4.5 billion. The PE firm’s investments are typically focused on the consumer and services sectors. Separately, KKR & Co is seeking to raise at least $750 million for its first Asia-focused technology, media and telecommunications fund. KKR is also raising $12.5 billion for its fourth Asia-focused buyout fund launched late last year.
However, 2012-2017 vintage funds are most likely to register poor performance.
For one, the funds would have been deployed during the bull market run of the last few years, buying up assets at peak valuations, and would, therefore, be seeing lower asset values. Second, the investments in those funds, which Preqin estimates to account for more than three-quarters of the unrealised value in private equity, are due for exits around this time. Given the current COVID-19 crisis, exits would be challenging and asset valuations would be weak, while portfolio companies would have had major disruptions to their businesses as well.
Meanwhile, limited partners of recently-raised private equity funds could get some reprieve. Preqin analysts expect that, given the likely decline in deal activity, general partners are likely to hold back on capital calls. Fund managers looking to add to the portfolios are likely to wait for valuations to fall, and economic conditions to stabilise before making decisions.
In its analysis of 2017-2019 vintage funds, Preqin noted that capital calls for those funds could be down by 38 per cent. Funds of those vintages account for nearly three-quarters of the $2.63 trillion in dry powder on call. By the same token, distributions are also expected to be lower by 19 per cent for the 12 months to June 2021.
But, LPs should also be ready to meet “outsized capital calls” in 2021, as fund managers ramp up capital calls to capitalise on lower asset prices, and deal volumes are expected to rebound.
Yet, as the current coronavirus crisis forces a rethink of economic and social order, and what counts as a resilient business model, acquisitions should also be more discerning.
Frontline’s Kabra has a tip for assessing businesses in such an environment: “Where there is dearth of capital, the survivors will come out stronger and with an advantage having hopefully focused on their cost structures and revenue potential.”