How is Private Equity Navigating the Changing Economic Environment?

As we end Q3, it’s useful to assess how Private Equity firms perform in what has been a very volatile first half of 2022.

Equity markets continued to trend downward in Q1 and Q2 2022, a time period when the S&P 500 suffered its worst first half since 1970.  The war in Ukraine persisted, but according to the Mizuho Group, a majority of investors shifted their attention to inflationary pressures on the world economy and what central banks around the world are doing to combat it.

In the first half, the Federal Reserve increased its funds rate on a monthly basis starting in April and has continued to do so during Q3. This ultra-hawkish stance comes at a time where U.S. inflation has hit a 40 year high as lockdowns, war and supply chain issues have caused prices to significantly increase. As a result, consumer sentiment has been low as prices for everyday necessities became unsustainable for the majority of the population.

Volatility was a major factor holding back the PE sector in the first half of 2022. As of the end of Q2, the VIX was up 67% year-to-date, far above the 10 to 20 range that is considered a good climate for issuance. Compared to Q1 2021, IPO proceeds were down a hefty 93%, while secondary proceeds (follow-ons and converts) were down 65%. Despite (or possibly because of) the low level of IPO issuance, 2022 IPO performance has improved, according to Mizuho.

In the technology, media, and telecom (TMT) sector, issuers raised $1.1 billion. There was only one TMT IPO of any significance (Credo Technology) during the first half, with none in Q2. The largest equity offering of the year thus far came out of the TMT space. Serial issuer American Tower (AMT) priced a $2.4 billion Follow-On to help fund its acquisition of data center owner CoreSite Realty (COR).  Shares were sold at an impressive 1.4% file-to-offer premium and a mere 2% discount-to-last trade.  These statistics show there is still investor demand in the new issuance market for businesses with proven track records and attractive growth platforms.

The picture is similar in healthcare. In the first half, the XBI hit the low 60s twice, and is 65% off the high water mark. Historically, biotech downturns last anywhere from seven to 30 months, and the end of Q2 marked 16 months of the current drop. Almost 70% of small and mid-cap stocks in the sector are trading with market caps less than $200 million, and 25% of biotech firms are trading with negative enterprise value. One impact of this is that IPO activity has dropped by 84% compared to the same period last year, with follow-on activity down 78%.

This is a difficult time for all sectors, but there have been difficult times in the past. For example, when the genomics bubble burst in 2001, the XBI dropped 75%, and tech downturns followed by recovery are too numerous to mention. As with every downturn, companies that preserve cash and focus on core R&D, create synergistic partnerships and M&A, and take a realistic view of their own viability will weather this storm. When the return occurs, companies that act judiciously will thrive, those that try to make a killing or overreach are unlikely to do well. As the saying goes, when the market turns bullish, pigs fatten and hogs are slaughtered.

In a downturn, cost management is critical, and one tempting way to control costs is through layoffs and hiring freezes. This is almost never a good idea. Riding out the downturn and fast, effective recovery will be fueled by the quality and stability of a Private Equity firm’s personnel. Companies should take a hard look at the quality of the who they have on the bus, are they in the right seats, and what seats need to be filled to make the right moves now and to be poised to move and move quickly when  the upturn starts. No company wants to meet the upturn by filling seats and breaking in new people, however good they may be.

Attracting and retaining top talent to maintain in the present and be poised to strike when the iron is hot in the future can be a difficult process, particularly for companies with a long history of old-style recruiting and hiring. A relationship with a Private Equity Recruiter that stands for the company’s purpose and the state of its market is likely to produce the best results. An effective recruiting partner will know how to identify the right combination of skill and experience to find the top candidates and put the PE firm in the best position to move nimbly and successfully.

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