For prospective deal making there are a few global key interactions that are important for PE firms to consider. With a view to that we turn our attention to the last economic decline in a bid to understand what the future may hold.
Deal making will understandably decline as a natural follow on from this economic climate. As purchasers demand lower prices and vendors hold out for better bids, there becomes a market mismatch for deal making. However, vendors will be likely entering into the market out of need, rather than want, providing an obvious bargaining tool for purchasers.
Lending will tighten; however, we doubt it will completely freeze as it previously did in 2008. We expect lending liquidity to reduce, especially on highly leveraged deals. This will naturally push up required equity stakes, but likely reduced asset prices will keep loan to values at sensible levels. However, 2019’s typical 80-85% loan to value on deals will be anticipated to decrease.
As PE firms move to fill this funding gap, this could lead to two distinct trends. Firstly, firms may decide to call the unprecedented amounts of unspent committed capital (commonly known as dry powder), currently valued at 2.5TN USD. This will put a liquidity pressure on investors (commonly known as Limited Partners) that already have agreed commitments in place.
Secondly, the other trend we may observe is firms plugging some of this liquidity gap as banks back off the credit scene. Since 2008 the level of opportunistic private lending funds has increased three-fold as PE firms look for short term dislocations to lend against at favourable rates. Favourable bridging finance or ‘loan-to-own’ financing will begin to emerge over the next 6-12 months. This will likely be an area of much controversy as PE firms will be providing predatory lending to distressed companies.
Competition for available deals with solid fundamentals will certainly increase in the favour of PE firms, just as it did in 2009. As public markets deflate, corporates will hold their cash and provide PE a great platform for bidding on deals.
Overall, deal making will decrease, but deal value may well increase. What’s more important now more than ever, is systematic and rigorous due diligence modelling for ultimate down case scenarios. Relentless stress testing and risk analysis will be of the utmost importance. Following this, PE firms may well be presented with some of the best long-term opportunities that have been seen in this Millennium.