European private equity is at a potentially critical juncture, according to UBS, and the Swiss bank is asking key questions that could determine its future.
How quickly will deal volume recover now that interest rates are falling?
Deal activity in private equity has started to improve, but is still only half the historical average. Falling interest rates (lower funding costs) and an economic “soft landing” should support a recovery in activity levels, UBS says.
“We expect deal activity to recover from 2022 / 2023 / 1H24 lows, but estimate global PE deal values need to double from 1H24 pace to return to
more “normal” levels. This could be a challenge. It could require the PE industry to be more inventive and flexible in the ways it finds to divest assets,” UBS analysts said in a note dated Oct. 4.
“Trading sales, secondary sales, IPOs could make up a larger share of exit volume going forward, alongside the traditional focus on sales to other financial sponsors. Some acceptance of lower exit valuations could also be a consequence.”
Can Private Equity performance be sustained at a high double-digit internal rate of return (IRR)?
Higher funding costs, combined with any concessions in valuations to stimulate trading activity, could reduce overall returns, UBS said.
The industry has no benchmark for achievable returns in a “normal” interest rate environment, and “we expect that the ‘best’ private equity players will be those that can sustain the highest returns through the operational improvement of the businesses they acquire and identifying and executing specialized differentiated agreements”.
Can private equity fundraising return to structural growth, with 20-40% “re-up” rates?
This is entirely possible, the Swiss bank added, although it noted two potential challenges to a rapid return to capital-raising growth: if we see lower absolute IRRs, that could reduce investors’ willingness to increase allocations to the sector – and with PE drawdown rates >2x distribution rates, it could take time to reverse the over-allocation to PE during the recent cash flow disruption, making it harder for LPs to increase distributions in the short term.
“We estimate that PE distribution rates may need to remain at double the current rate for at least a year to return most PE cash flow adjustment models to neutral positions,” UBS added.
Does private wealth represent an attractive opportunity to raise additional capital and can it support continued strong growth in assets under management?
Given the scale of the overall addressable market, it seems clear that private wealth represents a significant new capital raising opportunity for the industry.
However, our current discussions with investors focus on whether this is such an opportunity that is needed at least in part to offset short-term headwinds in institutional LP allocations, fund restructuring and potential fee margin pressure, or how much it really is an additional driver of growth for the industry.
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Reference;
Nurse, P. (2024) Is European Private Equity at turning point, UBS asks By Investing.com, Investing.com. Investing.com. Available at: https://www.investing.com/news/stock-market-news/is-european-private-equity-at-turning-point-ubs-asks-3653682 (Accessed: 13 October 2024).
