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There Are Plenty of Headwinds, but Don’t Expect Dealmaking to Come to a Screeching Halt

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Higher financing costs and lower prices for comparable public companies should combine to put the brakes on private equity deals. But with $1 trillion in cash waiting to be invested by private equity firms, transactions are likely to happen anyway, despite the long list of economic and market risks. 

PE deal activity will remain strong from a historical perspective, according to PitchBook’s latest report. But it will almost certainly slow from the record level achieved in 2021. In the first quarter of this year, PE firms closed 2,166 deals with a combined value of $331 billion. Although both deal value and deal count figures saw a significant decline from the last two quarters of 2021, they were higher than pre-pandemic levels, according to PitchBook data.

“Sponsors are sitting on more than $1 trillion in dry powder and are highly incentivized to deploy it,” according to the note. The PitchBook analysts found that PE-backed assets have historically grown with global gross domestic products, but the sheer volume of PE dry powder might make a big difference this time. “Despite the hawkish policy environment and the very real risk of recession, sponsors will continue to be persistent in deploying large sums,” the analysts wrote.

One way for PE firms to continue their dealmaking activities is through take-private deals. In the first few months of 2022, several public companies were taken private by PE sponsors such as Blackstone, Brookfield Asset Management, and Evergreen Coastal Capital. The surge of such deals came amid massive selloffs that have created attractive valuations for dealmakers. As for the target companies themselves, they are also pressured to “free up capital and shore up balance sheets” through take-private deals, according to the PitchBook note. 

Another sweet spot for dealmakers is in the information technology industry. Tech companies were among the hardest hit during the market downturn earlier this year, but PE firms poured more capital into the sector in the first quarter of 2022 than they did in the previous quarter. According to PitchBook, the valuation multiples for some tech firms have dropped to as low as single-digit levels, which have created attractive long-term investment opportunities for those without imminent liquidity concerns. In addition, strong tech companies can “withstand inflationary pressure with pricing power and stable cash flow growth,” according to the note.

“The key point is that PE firms will adjust to the current turmoil in the macroeconomic environment,” said PitchBook’s private equity analyst Jinny Choi. “We expect PE firms to adjust to falling valuations and market volatility, and [to] continue to find really attractive opportunities in the market.”

The PitchBook report added that exit activity will slow faster than deal activity. Institutional Investor previously reported that venture capitalists saw their exit activity come to a virtual standstill in the first quarter, and the same trend applies to the PE firms, too. Initial public offerings, which accounted for nearly 35 percent of exit value in 2021, have become an unviable exit channel due to heightened volatility in the public markets. According to Choi, the unfriendly exit environment in the public markets might cause companies to stay private even longer. 

Choi added that the longer holding period for private companies means that there could be an increase in sponsor-to-sponsor deals and corporate acquisitions. “Instead of relying on a profitable public market, companies might be sold to other buyers [in the private markets],” she told II

“Q1 still saw companies from different sectors seek strategic acquisitions to position themselves for continued growth,” according to the report. “Such consolidation plays are rampant across industries, and we expect more exit opportunities to appear as large corporations take advantage of the current macro environment to roll up PE-backed companies that may have adjusted valuations.”

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