Private equity deal flow will remain muted for the rest of 2020 as sponsors push the buying and selling of assets into the new year when more certainty is hoped for, senior UBS Group AG professionals expect.
The firm anticipated that valuations would fall, but this prediction has not materialized. More rationality to an overinflated environment of high multiple valuations would have created "a perfect vintage" for private equity, Simona Maellare, Global Co-Head of the Alternative Capital Group said during a private equity and leveraged capital markets press roundtable Sept. 23.
UBS has seen few deals, and they have been especially scant in Europe. Those that have completed involved companies that have proven to be coronavirus and recession resilient, and have occurred once market participants were able to evaluate the effects of lockdown on performance, Maellare said. Most transactions have been been in the healthcare and technology sectors, which did not see discounts. "There is a premium that needs to be paid for growth, one, but also for being recession resistant," the firm said.
UBS clients are keen to get comfortable with EBITDA, and business plans on both the buy side and the sell side, Maellare said. Most businesses have been negatively impacted by the coronavirus, resulting in softer EBITDA for the year and a dampened deal flow. Maellare anticipates an uptick in activity in 2021 when market participants have "at least a couple of quarters to prove that really the performance has stabilized," but that is based off the "tough assumption" that there is not another wave of the coronavirus and consequential lockdowns. "Business plans, valuations, and how to really price assets in this market remains, I think, the major challenge for most of the sponsor community and therefore, will limit the ability of most to transact," Maellare said.
"One of the major rules in leveraged finance is it's difficult to sell into a declining EBITDA," Sarah Mackey, UBS's EMEA Head of Leveraged Capital Markets said. A lot of businesses have been able to prove that the third quarter has been more stable, "but I think the outlook is still uncertain, and you can see that maybe some sellers are looking to just check their numbers and check where the financials are coming out before putting their assets up to sale."
Mackey expects the leveraged loan market will remain open over "next months and quarters" to support new transactions but added, "the hardest thing may be finding the deals to actually lend to in the coming months."
As a consequence of pushing out exit horizons, managers will be assessing their options. Maellare expects to see more sponsors selling stakes in their portfolio companies to de-risk, rather than take a hit on returns.
These options may include selling minority stakes in portfolio companies, control deals through which they sell 50% of a portfolio company to its newest fund and sell the remaining 50% to another sponsor "on the basis that they still believe there is a lot of growth in the investment, but again, in this environment, they want to de-risk." General partner-led recapitalizations also create options, allowing a fund to carve out remaining assets from a vehicle at the end of its life cycle, find new limited partners, and "effectively reset clock so that you have the flexibility to hold the assets for a bit longer," Maellare said.