The article was adapted from the original published on kpmg.com by Robert Ohrenstein, Partner, Global Head of Private Equity, KPMG International.
Private equity has proven to be innovative and resilient.
Private equity (PE) in Luxembourg has developed into a mature asset class—over 25,000 registered holding companies are now domiciled in the Grand-Duchy. Of the 25,000, a considerable number are being used as vehicles to structure private equity acquisitions. But just how resilient is this sector in light of the evolving economic situation?
As the virus is starting to take hold in over 150 countries and territories outside China, and particularly in the USA and Western Europe, we are already experiencing major economic disruption to both the wider economy and our private equity sector in particular.
Private equity is a very international and well-networked industry, and hence particularly exposed to the impact of the virus, so we hope above all that clients and colleagues remain safe and well. However, we are also reassured that this industry has the innovation and resilience to work through the unprecedented disruption that has already started. Many funds closed their offices and are working remotely. The effectiveness of the PE sector response will be important for the economy, given that PE firms are relatively small organizations that manage billions of dollars of AUM collectively representing a major global network of revenues, supply chains, customers and people.
We are seeing transactions being disrupted or put on hold, and this is likely to continue given the reliance on travel and meetings that underpin thorough transaction evaluation. Nevertheless several processes are continuing and quickly adapting to new ways of working remotely, with greatly reduced face to face interaction.
Most importantly however, private equity funds are making it their top priority to ensure the stability of their existing portfolio. In addition to these practical considerations, pricing assets will be challenging until the economic effects of the virus are better understood and this is similarly affecting the leveraged debt market. In such circumstances a deeper look at portfolio companies is needed. Exposure to potential economic risks need to be identified, as well as opportunities for rapid cost structure realignment, cash flow optimization and capex prioritization.
In addition to a slowdown in the transaction market, portfolio companies across a range of sectors are facing severe challenges and in certain cases distress. Others are facing unprecedented demand which presents its own issues for supply chain and customer management. Clearly the extent or duration of disruption is unknown at present, and hence forecasting demand and short term cashflow is difficult. We anticipate the Purchasing Management Index data for services and manufacturing to reflect growing economic stress, as social distancing causes a sharp decline in demand.
In these circumstances, having a strategy for short and medium terms liquidity management should be front of mind. One of the lessons we learnt from the 2008 global financial crisis (GFC) is that lenders are prepared to be flexible, if carefully managed. What is also different from the GFC is that the PE Industry sits on over $1.4 trillion dry powder that waits to be invested. In addition, PE market participants have broader operational expertise than we saw during the GFC. Hence with generally less onerous debt terms and better cash coverage, and with governments ensuring additional market liquidity, this will hopefully be a manageable situation in most cases.
Private equity has proven to be robust in dealing with trying times and its ability to outperform public markets and other asset classes over the full economic cycle is well known and understood by its stakeholders.
It is encouraging to hear of the first signs of businesses returning to work in China, although clearly there is still a very long way to go towards any kind of recovery.
We therefore remain upbeat that whilst we will no doubt face further extreme challenges in the coming months, the long-term industry fundamentals continue to be attractive, and perhaps in due course even offer investment opportunities caused by such significant market uncertainty.
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