ECA Survey: Private Equity Firms Shifting Focus to Deal Sourcing

by: Atta Tarki , Ken Kanara, Steven HaugGustav Brown 

Key Highlights: ECA Partners recently conducted a third survey of private equity investors and executives to understand how COVID-19 and ongoing economic uncertainty are affecting investment decisions in the private equity sector. Our first survey, conducted in April, found that most PE firms were shifting focus to controlling costs at their portfolio companies, while some were exploring opportunities for medium- and long-term growth. The second survey, conducted in May, noted a shift among PE professionals from controlling costs to sourcing new deals and growing revenues at their portfolio companies.

Selected findings from the third survey include:

  • Less emphasis on cost reductions/cash management: 40% of PE professionals expect to spend more time controlling costs across their portfolio (down from 87% in April and 81% in May)
  • More emphasis on closing deals: 61% of respondents expect to spend more time on closing deals (up from 21% in April and 28% in May), while new investments are increasingly the top destination for uninvested capital (60%, up from 47% in May)
  • Moderately more emphasis on growing revenues: 60% plan to spend more time growing revenues at their portfolio companies, up from 54% in May and 49% in April

 

Introduction: Private equity in the US accounts for more than $1 trillion in value and employs approximately 9 million Americans, with more $600m in wages earned in 2018. It has been one of the main drivers – and beneficiaries – of economic expansion since 2009. Like other sectors of the economy, however, PE-owned companies have been deeply affected by domestic closures and other restrictions enacted in response to the COVID-19 outbreak, as well as from the disruptions to the global supply chain, ongoing declines in global trade, fast-rising unemployment and general loss of consumer confidence that define the current economic climate.

Our surveys pose a series of questions to PE investors and executives on the following themes: (1) how the COVID-19 emergency has changed their strategic priorities; (2) how they plan to spend uninvested capital; and (3) when they expect company revenues to return to pre-COVID-19 levels. The second survey is comprised of more than 75 respondents from various corners of private equity: tenured committed funds, family offices and fundless sponsors, ranging from small ($0-100m assets under management) to very large (more than $10b assets under management).

The April iteration of the survey found a broad shift among PE professionals from closing deals and growing revenues to cash and cost management. It also captured the uncertainty of the time, with many respondents unsure when and to what degree the sector would recover. At the same time, it also hinted that the PE sector might recover more quickly than the economy as a whole, thanks to the $1.5t in cash that PE firms had amassed prior to the onset of the COVID-19 crisis.

In May, our survey discovered a shift from controlling costs at portfolio companies to sourcing new deals and growing revenues at existing portfolio companies, as well as a moderate increase in both sourcing and closing new deals. This suggested that PE investors were growing more comfortable with the overall economic climate, even as they grew more pessimistic as to when the economy would recover fully.

The third iteration of the survey, conducted in October, finds a much more significant shift – away from cost reductions and cash management and toward the sourcing and closing of new deals. And despite a second wave of COVID infections in July, and widespread predictions of a third over the Fall and Winter months, PE professionals continue to think the economy will recover fully by Q2 2021, same as in May. This likely reflects growing confidence that a vaccine will be available for the public around that time, which would facilitate the removal of restrictions on gatherings and businesses.

Taken together, these findings suggest that PE investors are looking for deals in anticipation of new growth opportunities within the next 6-12 months.

 

Time Allocation

We began by asking PE executives to compare (a) how they plan to spend their time over the next 6 months to (b) how they allocated time over the past 6 months. The most striking contrasts with pervious iterations of survey are on cost reduction/cash management and deal flow.

Large majorities in April (89%) and May (81%) reported that they planned to spend more time on cost reduction and cash management than they had previously. In October, only 50% responded in the same way. This is still a relatively large percentage, which speaks to the ongoing precarity of specific sectors, like retail and food/beverage, as well as continued uncertainty in the economy as a whole. But it also shows a clear shift from defensive strategies (aimed at shoring up rickety holdings) toward a more offensive approach to the market.

This is borne out by other findings in the survey. To begin, 50% of PE professionals expect to spend more time sourcing deals over the next 6 months, up slightly from the 47% who responded similarly in May. But 61% of respondents expect to spend more time closing deals than in the preceding 6 months, a far higher figure than we found in either May (28%) or April (21%). This suggests that PE investors are looking to take advantage of bargain prices before COVID vaccines receive FDA approval and current restrictions on gatherings, office work, travel and in-room dining are removed.

 

Uninvested Capital

The second set of questions focus on how PE firms plan to allocate uninvested capital. Overall, new investments remain the top destination (60%) by a significant margin. While relatively stable, investors are allocating 4% more of their fund to new investments over the next 6 months when compared to the previous 6 months.

The 4% uptick in funds being allocated to new investments corresponds with the slight drop in funds set to be allocated to existing portfolio companies. Inorganic and organic growth investments each fell by 2% when comparing the fund allocation plans for the next 6 months to the previous 6 months. In general, this set of questions shows that PE fund investors are continuing to follow the general investment strategy they followed during the past 6 months, with slightly more interest in new investments.

PE Survey Figure 2


Employee Compensation

We asked PE professionals when they expect employee compensation to return to pre-COVID levels. This metric serves as an indirect indicator both of the fiscal health of the PE sector and how strong the job market is for operating and portfolio roles. In April, the mean response was that salaries would return to pre-COVID levels by Q1 2021. Respondents are now moderately more pessimistic, with the mean response shifting to Q2. This is likely driven by heightened knowledge about the virus – the fact that it is near impossible to get rid of without a vaccine, and that the economy can’t truly recover until its threat recedes – and increasing confidence that the first vaccines will be available before the end of Q2. As such, it signals that PE investors expect continued uncertainty until a vaccine arrives.

At the same time, Q2 2021 is not far out – arguably this finding also points to optimism that, once the threat of the virus recedes, the PE sector should be back to full strength.

PE Survey Figure 3


Demographics

The survey offers a snapshot of private equity in the United States. Respondents hail from tenured committed funds (56%), fundless sponsors (22%), family offices (15%) and other vehicles for private equity investments (7%).

Respondents also range in terms of assets under management (AUM). Representatives from funds under $100m AUM account for 30% of respondents, while those in the $100-500m AUM range account for another 30%. An additional 15% of respondents come from funds in the $500m-1b AUM range, while 15% come from funds in the $1b-10b AUM range and 10% come from funds with more than $10b AUM.

Conclusion: Whereas the second iteration of the survey largely upheld the findings from the first, the third iteration finds several major shifts in the priorities and expected activities of PE investors over Q4 2020 and Q1 2021. The most striking are with how PE investors plan to spend their time over the next 6 months: much less on controlling costs and cash management, and much more on closing deals. Equally, PE investors are allocating a larger proportion of uninvested capital to new deals. This is a sign of increasing confidence in the PE sector’s recovery.

At the same time, PE professionals remain cautious in their overall assessment of the economy. Few expect salaries (or the economy) to recover before Q2 2021 – when vaccines should start being available to the public at large. Furthermore, while PE investors are placing less emphasis on controlling costs and cash management over the next 6 months (relative to the preceding 6 months), it is worth noting that they are still placing significantly more emphasis on these activities than they were pre-COVID. Keeping this in mind, it is safe to say that the overall tenor of our findings is one of cautious optimism.

 

Published On: October 23rd, 2020|Categories: Private Equity|

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