By Sergey Sheshuryak, Adams Street Partners – To gain a perspective on the private equity market in Europe in the second half of 2020, we start by looking back to the seemingly distant past of 2019 – before pandemic-related shutdowns, social distancing, central bank stimulus plans, and Zoom meetings.
By Sergey Sheshuryak, Adams Street Partners – To gain a perspective on the private equity market in Europe in the second half of 2020, we start by looking back to the seemingly distant past of 2019 – before pandemic-related shutdowns, social distancing, central bank stimulus plans, and Zoom meetings.
As Private Equity Wire has pointed out, the European PE market outperformed the rest of the world in 2019. Benelux, Nordic, and UK LBO funds delivered the strongest returns among European countries last year, delivering IRRs of 16.64%, 16.29%, and 15.6%, respectively. Funds in the so-called DACH nations, Germany, Austria, and Switzerland, saw a sharp improvement in performance, with an IRR of 10.9%, up from 5.8% for the prior year.
Q1 2020, on the other hand, brought an entirely different scenario. The European buyout funds which Adams Street Partners has been tracking across the market as an aggregate expect valuation markdowns of about 10-15% versus the fourth quarter of 2019. We believe we are now in a position to assess the market’s moves in the second quarter, which we see providing some cause for cautious optimism regarding the climate for European buyouts for the balance of this year. While it is too soon to declare that European PE markets are recovering, there seems to be little further deterioration – and perhaps some welcome signs of stability. Among the GPs we have been in touch with, valuations on portfolios appear to be flat to slightly up in Q2 versus Q1.
Action by governments, GPs stabilised portfolio companies
Although we do not expect European funds to deliver the impressive returns that characterized 2019 in 2020, the region appears to be on track to perform relatively well as compared with the rest of the world’s PE markets. Some Governments’ actions to lock down early, along with aid programs for businesses, helped soften the economic blow of the pandemic to some degree. Also, as in the rest of the world, GPs were focused on helping their portfolio companies cope with the economic disruption of COVID-19. Because GPs take a systemic approach to measuring the performance of their portfolio companies, they were able to quickly assess how businesses would be impacted. Armed with advice from GPs, companies could take prompt action aimed at ensuring the health and safety of employees and customers, bolster liquidity, and reduce costs and cash burn. In some cases, GPs assisted portfolio companies in navigating complex government policies and regulations in order to qualify for aid programs.
While the prospects for economic recovery vary from country to country, we at Adams Street believe that industry sectors, not geography, will largely determine how portfolio companies will fare in the balance of 2020 and beyond.
Outlook for key industry sectors
In Europe, as in the rest of the world, the industries we see facing the greatest challenges include hospitality, travel, and in-person retail, which were hit hardest by lockdowns and which we believe will take the longest to recover. We expect that some companies in these sectors will need to permanently alter their business plan. If a business such as a retailer or restaurant was able to quickly pivot to an e-commerce model, it is now positioned to take share as the economy reopens. In short, we believe the outlook is brighter for consumer-facing businesses that have – or can transition to – a successful digital strategy.
Not surprisingly, we anticipate that companies in the healthcare sector should emerge from the pandemic in a strong position. In particular, businesses in the pharmaceutical, personal protective equipment, medical device, and medical technology sub-sectors, and those that can adopt a tele-medicine model, should perform relatively well. Provider services companies, such as dental and eye care practices, were heavily impacted as lockdowns forced patients to delay visits, but we expect those businesses to recover as delayed procedures are able to be performed.
Manufacturing and industrial companies require a nuanced approach. For example, many companies that make equipment or parts for the auto or airline industries will, we believe, have a difficult year. However, we expect that companies that operate in segments delivering to well-performing end markets should see a V-shaped recovery (if they were impacted at all).
Companies in technology-oriented areas have been performing well. Companies that benefit from the business and lifestyle shifts catalyzed by the pandemic, such as the move from offline to online in areas like online education, e-commerce, remote work, payments, etc. have been performing particularly well. Other promising technology sub-sectors that we see include the hardware and software area, as well as internet infrastructure.
The Fundraising and Deal Environment
As Europe emerges from its traditional summer recess and activity picks up in the fall, we expect to see a “strong get stronger” fundraising pattern for European buyout GPs. We anticipate this to be the case where LPs still need to deploy capital, but are unwilling or unable to travel to conduct due diligence on new GP relationships. Those that are unable to consider new relationships are, we believe, likely to focus on increasing their commitments to GPs that are “known quantities” – writing bigger checks to those that have performed well for them in the past.
While we expect 2020 to be a slow year for European buyout GPs, we anticipate some level of deal-making activity to come back to life in the rest of 2020. We believe that deals in the negatively impacted market segments are generally unlikely to happen in the near term, as it would take time for the valuation expectations to adjust and/or the business to improve. We expect deal activity for the rest of the year to be in the less disrupted segments where businesses continued to perform relatively well through the lockdown, or are expected to recover quickly. Add-on acquisitions to existing platforms is another area where we see activity resuming, with portfolio companies taking advantage of their more fragile competitors in the current market.
In conclusion, in our view the European buyout market has held up well so far. However, there are major uncertainties and challenges ahead through the rest of 2020. We anticipate that we will see the private equity active ownership model prove its value in this crisis – GPs supporting their portfolio companies through the pandemic and positioning to invest in promising industry sectors and businesses with the potential to deliver strong long-term performance.
Important Considerations: This information (the “Article”) is provided for educational purposes only and is not investment advice or an offer or sale of any security or investment product or investment advice. Offerings are made only pursuant to a private offering memorandum containing important information. Statements in this Article are made as of the date of this Article unless stated otherwise, and there is no implication that the information contained herein is correct as of any time subsequent to such date. All information has been obtained from sources believed to be reliable and current, but accuracy cannot be guaranteed. References herein to specific sectors are not to be considered a recommendation or solicitation for investment in any such sector. Projections or forward-looking statements contained in the Article are only estimates of future results or events that are based upon assumptions made at the time such projections or statements were developed or made; actual results may be significantly different from the projections. Also, general economic factors, which are not predictable, can have a material impact on the reliability of projections or forward-looking statements.
