Private Equity Opportunities in an uncertain market
For the last 11 years the United States has seen record growth, delivering the longest bull market in the country’s history. Despite this tremendous growth, some investors are wary that this trend is unsustainable in the long term. After the inversion of the yield curves for U.S. treasury bonds, recession seemed a likely outcome. This was the first signal to U.S. investors that a potential recession could occur, and they had to take precautions. Yet the markets were able to correct themselves, and growth is still occurring. In recent times, investors have shown themselves to be more risk averse due to the state of the global markets, placing risky assets at a discount. An economic slowdown, or even just the fear of one, positions private equity firms for increased activity as private equity is a long-term investment and economic slowdowns have traditionally been over shorter periods, allowing for cheaper entry.
The European markets slowed in 2019. China also faced multiple threats to its markets in 2019 including the U.S.-China trade war. With these and other market uncertainties, investors are reducing risk in 2020. For example, the price of gold, which is often viewed as the ultimate safe-haven investment, has reached a seven-year high. The market uncertainty has caused private equity firms to increase their cash positions and now they are ready to make investments.
Entering 2020 with further uncertainties looming such as the Coronavirus, U.S.-China trade war, the election year in the U.S., and Brexit, it appears as market growth will continue to slow. The Coronavirus’ impact on China and the world in general might be the most pressing risk at the moment. The number of cases increases daily and factories and businesses in mainland China such as Foxconn, Apple, Starbucks, and others have temporary closed. Companies dependent on Chinese-made parts have been forced to slow production as well. Even the airline industry is projecting significant losses in revenue as travel has declined due to the Coronavirus.
Impact on the Private Equity Market
Global growth was generally expected to slow for 2020 even prior to the Coronavirus; as we enter the first two months of 2020, we have seen that slowing is a near-certainty. With 2020 starting out as a higher risk, lower return year, investors are actively searching for attractive alternative investments.
Certainty will return to the global markets as Brexit will finalize, the U.S.-China trade war will hopefully end, the U.S. election is in November 2020 allowing the U.S. to know what the economic and political agenda will be for the next four years, and the Coronavirus may prove to be a threat for the near future. Private equity investments are typically long term, with most large private equity firms creating funds that mature in seven to ten years with few exits before
maturity. Private equity may be in a position to benefit from lower valuations for target acquisitions in the near future, producing higher returns when the funds mature.
From obstacles to Opportunities
Depressed valuations, such as in the UK, attract private equity investments. Mayer Brown, a global law firm, noted that the total annual value of acquisitions of UK companies by U.S. private equity increased 53% from 2018 to 2019 as the UK faced the uncertainty of Brexit.
The Brexit occurrence created a discounted investment price. The Brexit announcement drove the markets in the UK down and private equity companies realized this. These firms are taking advantage of the undervalued markets in the UK. Private equity firms are operating differently; instead of investing in rising companies and markets, they are using their sizeable resources and capital to take advantage of the negative markets.
Target companies that private equity firms wanted to buy in the uncertain period before the general election in the UK became so devalued to the point where private equity firms are currently willing to invest despite the negative effects of the Brexit announcement in UK. The target companies are available at a discount, creating potential for private equity firms to make profits with some currency risk involved. Even though the markets are slowing, the risk of a global recession seems unlikely as the U.S. experienced 2.0% GDP growth in Q2 and 2.1% GDP growth for both Q3 and Q4 (estimated) of 2019, per the U.S. Bureau of Economic Analysis.
With their larger cash positions, private equity firms are poised to increase their investments. Also, the current market uncertainty seems to favor private equity investments due to cheaper entry. Private equity firms have learned from the 2007-2009 recession and is entering 2020 with increased cash supply and healthy balance sheets. Private equity firms, as well as acquiring firms in mergers and acquisition are able to take advantage of the depressed markets by buying out smaller companies that are struggling in the current market conditions at a discount. Expect increased private equity investments in markets where there are depressed assets, just as observed with the significant increase in private equity activity in the UK in 2019.
By Austin Brattli
King's Private Equity Club