Opportunities for Private Equity Firms

The sideways movement in the number of private equity transactions can be explained by the cooling economy, higher interest rates and geopolitical uncertainties. However, the long-term prospects for private capital are positive and promise attractive returns. Against this background, how can players optimize their portfolio in order to be successful in the long-term?

‍

Key Takeaways

‍

After more than doubling in Europe over the last ten years, the private equity market is stagnating
The number of exits has declined (2023: PE investments/exits ratio 2.44x) – IPOs in particular have almost come to a standstill
Private equity firms have the funds and foresight to optimize their portfolio in the current phase
Well-prepared mid-cap transactions make strategic sense and are financially attractive
The quality of the portfolios and the use of value enhancement concepts are the key to success

‍

The weak economic environment of recent months, geopolitical uncertainties and higher interest rates have generally led to lower valuations and, as a result, different price expectations on the part of buyers and sellers. Consequently, the number of exits fell in 2023 (PE investments/exits ratio 2.44x), a trend that is likely to continue in 2024. IPO activities in particular came to a virtual standstill and investors are increasingly turning to M&A – where they have more control over pricing – for exits.

‍

“The European PE investments/exits ratio will reach a 15-year high due to a muted exit market stemming from price dislocation.”

(Pitchbook, November 2023)

‍

‍

In Europe, private equity volumes (AUM) have more than doubled in the last ten years: from around EUR 400 billion in 2014 to more than EUR 1 trillion in 2023. However, financing larger deals is expensive in the current interest rate environment and is therefore associated with risks, which puts pressure on leverage potential. Capital is generally available for medium-sized transactions to take advantage of opportunities, and there is also a certain amount of pressure to deploy the financial resources profitably. This can take the form of smaller, targeted add-on acquisitions, which empirically represent the most value-creating M&A strategy.

‍

‍

Value-creating acquisitions – as part of a buy-and-build strategy – rely on in-depth knowledge of the key megatrends: decarbonization, digitalization and deglobalization. It is also important to consider the respective sector insights. The advantages of mid-cap transactions are:

‍

Attractive prices and financeable volumes
Acceleration of clean energy transition and digital transformation
Expansion through growth-oriented geographic coverage
Addition of talent and innovative strength
Fast and successful integration

‍

In view of the more difficult financing conditions and reduced valuation level, private equity firms must focus on designing a comprehensible business model for their portfolio companies as well as consistently generating free cash flow and creating financial value. Implementing value enhancement concepts increases both the value of the portfolio company and transaction security.

‍

Value-oriented steering of the portfolio companies hinges primarily on transparency in the management areas relevant for financial value creation. Economic profit and free cash flow are used to measure financial value creation for the products, customers and markets, and to manage it consistently via the respective value drivers. Benchmarks can also be helpful in formulating realistic ambitions for growth, cost and capital efficiency. In addition, efficient monitoring of the portfolio – especially in difficult economic times – allows the identification of consolidations and divestments needed to protect existing values.

‍