We held a roundtable webinar on Private Equity on 29 April moderated by Aoifinn Devitt, with Stephan Breban (Member of the Advisory Board, Dean Wetton Advisory), Andrew Kelsen (Portfolio Manager, Chicago Teachers' Pension Fund), and William Bourne (Principal, Linchpin) on the panel.
The market focus over the pandemic crisis has largely been on public markets, so in the first of a series of webinars Linchpin will be holding over the next eight weeks we turned the spotlight on Private Equity. With 42 people Zooming in, (one with a fetching COVID-19 background), we spent an hour discussing what might happen to both GPs and LPs.
This is a very different crisis from previously, and as one of the panellists said, ‘The world’s economy was just switched off,’ but will at some point be switched on again. Like public markets, PE will have winners and losers, largely depending on which sectors they are concentrated in. We noted that the stresses so far are initially among the private credit lenders to PE rather than the GPs or LPs themselves.
Triage will be the immediate activity, i.e. which companies to save and which not. The next question will be how to inject cash to those which need it when increasing leverage is not an option. Revolving facilities may solve the problem in the short-term but will be more expensive.
The panel thought there would be a mixture of new cash injected from the mountain of dry powder and re-negotiations with debt providers at the expense of equity holders. However, it is not completely clear whether the GPs or the debt providers will have the whip hand in this bargaining, as they have a somewhat symbiotic relationship.
Q1 valuations will clearly be lower, and the point was made that it would be wrong to adjust Q4 ones, even if with hindsight they were too high. The panel spoke about the denomination effect, whereby PE weightings will appear to be higher because public equity holdings are marked daily. The point was made that Q2 and Q3 valuations will be much more important than Q1’s.
We then looked at the interactions between LPs and GPs. While some in both classes will inevitably find themselves short of cash, the panel didn’t see that as a generic problem given the amount of dry powder available. The panel noted that some GPs are calling money early, and that PE LPs may also be LPs in the private credit funds providing the leverage to the PE funds, so have skin in both games.
Returns will of course be lower: some underlying companies will be put out of their misery, others will see equity holders diluted through restructuring, exit values are likely to be lower and leverage will have to be reduced. We noted that the lowest vintage returns were those about three to four years before an economic downturn, and that overall returns tended to be 4-5% lower than normal.
The best returns, unsurprisingly, come from those vintages which pick up assets cheaply i.e. probably the current and next ones. Apart from the obvious sector winners, the point was made that supply-lines are likely to shorten and manufacturing businesses in western countries are likely to do well. The panel was wary of co-investments but didn’t expect fees to come down massively in general. There were mixed views on secondaries: one panellist though they were heading for disaster; others that they would continue to mitigate the J-curve effect.
We also discussed the longer-term future. The point was made that, as with public markets, PE will have to pay more attention to company stewardship and non-financial risks. One panellist thought they already were, but the retort to that, if true, is that they need to articulate it better. Overall, however, we believed that PE would not change markedly, albeit there might be greater return variation depending on sector, manager quality, and the financial structure behind each asset.
If you would like to listen to the full recording (recommended!) please contact us here.