• Aggregate buyout volume brings 2022 just 6% above pre-pandemic dealmaking
• Shift to buyers’ market triggers change in auction process dynamics
• Carve-outs, operational improvement likely to yield opportunities

2022 had a lot to live up to following the heady heights of private equity activity last year. But, after a war and the most aggressive series of interest rates hikes in decades, the contrast could hardly be starker.

PE buyouts targeting European companies in H2 2022 plummeted 64% versus the same period in 2021 to EUR 44.5bn, as the consequences of supply chain-driven inflation and monetary tightening hit dealmaking. Deal volume for the full year 2022 is set to be just 6% higher than 2019 – the last “normal” year before the pandemic and the subsequent rebound, an analysis of Dealogic data indicates.

In fundraising, new buyout funds with European investment in their mandates are so far down 40% in volume and 20% in total capital raised, Unquote Data shows. With sponsors fighting for space and investors constrained by liquidity issues, the year saw the exacerbation of a bifurcation trend that punished new or undifferentiated managers and favoured megacap fundraises, such as those closed by Advent, Permira and Brookfield.

With little time to lick their wounds, financial sponsors and advisers will now have to focus on finding a new footing in a transformed landscape.

“We’re turning the page on an abnormal fundraising and capital deployment environment,” Frédéric Stevenin, managing partner at PAI Partners, told Mergermarket. “To some extent, we will face a slowdown, but it’s a great time to be deploying – you just need to do it carefully, with the right understanding of the market.”

Source: Dealogic

Mind the gap

With a few weeks to go and some deals to be inked, 2022 is set to finish 8% below last year in volume terms with a total of 919 transactions, Dealogic data shows. Total buyout value is down 21% to EUR 213.7bn, even after the boost received from Blackstone and Edizione’s EUR 40.5bn acquisition of Italian transport firm Atlantia.

Appetite for computer and electronics businesses remained strong, with the sector making up 28% of 2022’s dealflow. Meanwhile, the share of deal value in two of Europe’s most mature PE markets – the UK and France – fell from 27% to 23% and 16% to 13% respectively, thanks to large-cap deals in other markets such as Italy and the Netherlands.

In part, the slowdown in dealmaking has been a result of a gulf in buyer and seller valuation expectations. This has been especially acute in the large-cap space, where some processes were delayed or even ground to a halt. UK-based sponsor Montagu pulled the sale of DACH ophthalmology business Artemis in October after a EUR 1bn price tag went unmet, as reported by Mergermarket. In the same sector, H2 Equity Partners had to turn to bilateral discussions for UK-based Optegra after auction bids did not meet the hurdle.

The current market is also leading to a shift in the dynamic in private equity auctions, with some processes moving at a slower pace and buyers taking more time on due diligence, especially when it comes to making EBITDA adjustments. In light of this, vendors are increasingly approaching only a select group of credible buyers, prioritising those who can secure the necessary debt to execute a deal.

Some private equity firms are also more likely to lengthen holding periods, with two-year ownership and “flipping” portfolio companies based on multiple arbitrage alone likely to be confined to history for some time. Continuation funds are becoming increasingly appealing while traditional exit routes are more challenging, as discussed in a Mergermarket analysis published earlier this year.

Some examples of this dynamic include GHO Capital’s minority stake sale plans for UK-based Sterling Pharma, with the sponsor weighing up transferring its remaining majority stake to a continuation fund or a later-vintage vehicle, as reported. Transfers have already completed for Equistone’s Sicame and Ufenau’s Corius and Altano, among others.

With exit plans pushed back, value creation efforts are taking centre stage. Buy-and-build will offer one avenue to generate value, according to Mark Corbidge, managing director at Sun European Partners, which had made 20 bolt-ons for the companies across its current portfolio by the end of summer this year. Many founders are continuing to give “serious thought” to selling their businesses, he told Mergermarket, prompted in part by the exposure of the fragility of their earnings and potential health scares during the Covid-19 pandemic.

“Doing an add-on means that we can bring a business into an entity that is much stronger from an equity perspective and has debt available to make acquisitions,” Corbidge said. “We also usually ask the founder to reinvest alongside us, and that 20% reinvestment could well be worth the 80% they are taking off the table today by the time of the exit, which maintains alignment of interests and provides us with a sufficient amount of their time to assist us with integrations.”

Bridge over troubled water

Sponsors with multi-cycle experience and a track record of making operational improvements to challenging businesses are likely to fare well in this market. “The really interesting part of investing in this market is deciding when you can play offense, as well as defence,” said Thomas Hofvenstam, managing partner at Triton. “You need to invest in growth to ensure companies are well-positioned to increase market share, develop new products and capitalise on digitalisation. These things play an instrumental role in determining how favourably positioned you are coming out of a recession.”

Although a surge in special situations activity was kept at bay by government support packages during the worst of the Covid-19 pandemic, distressed investors will be keeping their ear to the ground, seeking ways to take over or enter the capital structure of potential turnaround situations.

Businesses that rely on discretionary consumer spending are an obvious potential source of distressed deals, with UK-listed (and previously VC-backed) online home furnishings retailer Made appointing administrators in November 2022 following a profit warning in August.

Many sponsors will also be eyeing carve-out opportunities as corporates seek to streamline. Processes being circled by sponsors include International Flavors & Fragrance’s Frutarom Savory Solutions and IWG’s digital booking platform Instant Group.

Strategic players have been less active than usual in buying private equity-backed companies in recent months, possibly indicating a liquidity crunch that they might need to solve through divestments, as reported by Unquote.

Such deals can sidestep the challenge of securing leverage in a challenging financing market, with vendors providing loans as an initial step. “About 40% of the deals we do are carve outs and primaries,” said PAI’s Stevenin. “In the current market, a lot of sellers are focusing on cleaning their portfolio – financing is less of a concern in these deals as you can approach these questions in different ways – for example, the vendor can provide some financing.”

Elsewhere, sponsors will continue to look for resilient businesses, prioritising business models backed by underlying long-term trends such as digitalisation and sustainability. Businesses likely to still command buyer interest include those operating in the financial services and healthcare sectors, with recent deals such as Nordic Capital’s sale of UK-based immunodiagnostic kits and reagents producer The Binding Site commanding a GBP 2.25bn valuation.

The recession-driven cooldown in dealflow and valuations is, however, expected to feed good private equity vintages for the next few years. With capital markets downgraded and this price gap soon expected to drip down to private markets, sponsors are poised to snap up cheap assets. 2022 may have been an expectedly frosty year, but history shows that difficult years create space for strong returns.