Fund managers are buying time to make their investments pay

Julie Neal is a Director and Private Equity sector specialist at Vendigital. Tom Acfield is Strategy Director at Vendigital. They recently shared their insights with Funds Europe.

Lower growth and higher interest rates have forced a change of approach among private equity (PE) fund managers. With higher valuations harder to achieve, firms are having to look beyond the usual steady stream of buyouts and disposals to find other ways to make their investments pay.

Many PE firms are finding the current market conditions challenging and behaviour is shifting accordingly. Reports published recently on the European market show that PE exits fell significantly in the first half of 2023 compared to the same period last year. Instead of pursuing exit strategies, some PE fund managers are choosing to push back the horizon for their portfolio companies by a year or more, in the hope that the rate of inflation and interest rates will have fallen and the market will have improved by then.

In the meantime, fund managers are focusing inwards on their portfolio companies, looking for ways to optimise value at the point of exit. This may involve taking a more hands-on approach; helping portfolio companies to identify levers with value-driving potential such as operational efficiency, pricing, technology and data systems. Taking this approach can help to drive revenues to cover the additional cost of finance, due to higher interest rates and longer exit cycles. Working with companies in this way, can help to accelerate their maturity and give them a better story to bring to market further down the line.

To boost liquidity in the meantime, some PE firms are branching out into the private credit market, where demand for long-term finance at a competitive rate of interest is strong.

Despite the longer exit cycles, the PE-backed deal market remains active. Buyouts and exit deals are happening, but there are fewer of them. As well as focusing on secondary markets, many firms are targeting high quality assets in specific sectors such as healthcare, technology and cybersecurity, due to strong tailwinds and significant growth opportunities in these areas. A report published recently by EY confirms that more than a third of PE-backed acquisitions in Europe in the first quarter of 2023 were in the technology sector.

More ‘bolt-on’ acquisitions are being considered as a means of boosting the enterprise value of portfolio companies by growing revenues and leveraging economies of scale. Such acquisitions enable portfolio companies to branch out into an adjacent market or new geographic area, or simply gain critical mass in their target market. For example, an acquisition strategy could allow a digital platform company to scale up quickly without increasing the size of its workforce or expanding its operational footprint.

Opportunistic deal-making is still very much on the agenda too, particularly as many firms still have plenty of dry powder. With some larger companies looking to realise cash by divesting underperforming or non-core businesses to focus on driving growth, ‘carve-out’ acquisitions have become a key investment opportunity.

Data scientists

To assess such opportunities and track the performance of portfolio companies, many PE firms have a team of data scientists to analyse key performance data and other market and third-party information. In some cases, market-specific AI algorithms have been developed to provide accurate demand forecasts and de-risk investment decisions. These predictive AI-based tools are becoming increasingly critical in working with portfolio companies to optimise value creation.

Despite pushing back their exit horizon, PE fund managers have no time to waste in onboarding the skills and technologies they need to enhance portfolio companies and support value creation. The right tools can also help to de-risk critical investment decisions in a challenging market.