Given that a key component of fair market value calculations for PE-backed companies are publicly-quoted comparables, we can safely assume rock bottom for PE fund value during the Covid-19 Crisis will parallel timing for public equity lows – as during the Global Financial Crisis (see first graph on p. 1). A plunge below March’s nadir is a real danger. But barring an infection resurgence, the likelihood is that the Covid-19 bottom for PE and for stocks has come and gone. PE plunged less than the stock market in Q1 and any bounce back in Q2 will be muted versus the big stock gains through early June.
From the 1,300-plus conversations we’ve had with general partners and limited partners since early March, it’s evident that the vast majority now want to invest, stoked by memories of missed opportunities during and after the GFC. But the biggest complicating factor for any recovery of PE activity may prove to be the growing disparity between bleak economic prospects and relatively high market values.
Managers began finishing Q1 reports in late-May. With a majority now in, Triago estimates net asset value fell 7.2 percent for PE broadly defined (encompassing buyout, credit, growth, real assets and venture capital, from all regions). That’s considerably better than the 20 percent-plus drops most major stock market indexes suffered.
Given the ex post facto nature of PE reporting and what now looks like fire-sale pricing for many stocks at the March low, Q1 fair market value for PE assets was likely influenced by the recovery in public markets. This is hardly surprising at a time when getting a bead on discounted future cash flows is exceptionally difficult.
During the GFC, PE asset values took 24 months to bounce back from market lows (see second graph on p. 1). With companies supported by unprecedented amounts of government stimulus, PE values have fallen considerably less than during the GFC, and look set to recover more rapidly. With most investors maintaining or increasing PE allocations and with managers eager to deploy record levels of committed but unspent capital, this is liable to significantly reduce the opportunity for bargain hunting.
A highly uncertain economic outlook combined with high prices for most assets, means that more marginal forms of PE are coming to the fore, including earnouts, distressed investing (managers should really shine here, with many more GPs prepared to take the plunge than during the GFC); PIPE, or private investment in public equities (focusing on more distressed stocks); and specialized niche investing in everything from healthcare to digital infrastructure. As depressed economic conditions continue, liquidity-driven deals should also increase, including carve-outs, structured credit and preferred equity investments (often done in the form of co-investment).
Barring an infection resurgence, the impact of Covid-19 on medium and long-term corporate cash flows should be clear by the end of the third quarter. Clarity on this front – as during the GFC (see third graph on p. 1) – will enable accurate pricing and kickstart the stalled secular growth of the secondary market for closed PE funds (volume rose to $83 billion last year from $3 billion in 2002). Compared to the GFC, the secondary market is better positioned for a swift recovery – buyers hold $140 billion in dry powder, at least four times as much as in 2008 (for a debate on the future of single-asset secondaries versus traditional LP stake sales, see our roundtable on p. 3).
Feeding off momentum in the first two months of 2020, fundraising amounted to $129 billion in Q1, some 6 percent higher than in the same period last year. But following March lockdowns, most fundraisings were put on hold. Triago assumes April through June will be the worst quarter in a decade for commitments. Fundraising went into a four-year slump when the GFC hit, as a sharp drop in realized investments left PE programs short of cash (see fourth graph on p. 1). This time around a quicker return to pre-crisis pricing – foreshadowed by today’s milder falls in asset values – will fuel a rapid return to strong levels of private equity capital commitment.