The private equity industry has turned its attention away from dealmaking activity to focus on its portfolio companies for the time being, amid the immense uncertainty driven by the coronavirus outbreak.
Processes that were near to closing are being completed, but those that were not as far along are, on the whole, being delayed or canceled, according to market participants.
Private equity firms are keeping a particular eye on their portfolio companies operating in sectors that have been hit by uncertainty and social distancing measures, such as travel; food, beverage and restaurants; and entertainment and theaters.
But the broader business market is also being advised of knock-on effects to businesses within the supply chain as companies review their spending and costs. "That can actually have a trickle-down effect which could damage areas that we would never have earlier thought," S&P Global Ratings Inc. U.S Chief Economist Beth Ann Bovino said during an S&P Global Market Intelligence webinar assessing the outlook for 2020 on March 24.
The key focus for most private equity firms has been to seek liquidity for their portfolio companies. "We have seen most portfolio companies looking to draw down any available cash under their financing arrangements," Linklaters partner Ben Rodham said.
The Boston Consulting Group Inc.'s Antoon Schneider, who leads the firm's private equity work in London, said there are enough people in private equity firms with knowledge of the last financial crisis, and firms have developed strong operating partners across the past couple of years. "They are staying very close to portfolio companies, they assess them case by case, and I would say, in some instances, they are taking quite significant action to release liquidity," he said.
Companies in the hardest-hit areas are drawing down revolving credit facilities. Bloomberg News reported March 12 that The Blackstone Group Inc. and Carlyle Group Inc. have called on portfolio companies to tap credit lines. Blackstone said in a statement to the outlet that there was no firmwide directive, but it is evaluating the financing requirements of certain companies "directly impacted by COVID-19." Carlyle is reportedly recommending portfolio companies draw credit lines in certain instances. EQT AB (publ) has also called on some of its companies to draw down revolvers "to be prepared for a more complicated time," CEO Christian Sinding said during a March 19 update call.
These reports spurred a lot of activity with regards to considering drawing down revolving credit facilities, finance partner Gary Rosenbaum at law firm McDermott Will & Emery LLP said during a webinar on contingency planning for private equity portfolio companies. The drawing down of revolvers is "a standard part of the playbook" during crises, but he noted it does see leverage going up for these companies, which could create a ripple effect.
Private equity firms should also sit down with advisers, look at documents carefully, and make sure there are no implications with regards to material adverse effect, a term used as a threshold in measuring the effect of an event. Recently, some lenders have pushed back on funding revolver draws, McDermott corporate finance partner Stephanie McCann said during the webinar. "Lenders are becoming a little bit more conservative and really looking at the company before they're making those revolver draw funds available to the borrower. And [they're looking at] whether a company is going to be able to satisfy the no material adverse effect condition," she said.
The firm also urged private equity portfolio companies to review its cash flow every day. "Really, at this point, it's a daily basis," Felicia Gerber Perlman, co-head of McDermott's restructuring and insolvency practice said. In the longer term, companies should evaluate impact through 2020 and even into the beginning of 2021 "as we're not certain how long the impact of the coronavirus [is going to affect the] economy," and adjust their business plans accordingly, she added.
Dealmaking has slowed across the board as markets take stock of the unfolding crisis.
Market participants are taking a "wait and see" approach, Lincoln International LLC Managing Director Chaim Lubin said during the S&P Global Market Intelligence webinar. "We're not going to see too many new deals come into the market for the near term and maybe for the foreseeable future until things clear up," he said.
There is a lot of appetite from private equity firms looking for situations that may need capital immediately, but the asset class is limited by the availability of credit because new credit isn’t being deployed, Lubin said.
With that in mind, there may be some private equity firms that over equitize their deals with the idea of refinancing the companies once things start to recover, he said.
Some industries are still doing "quite well," such as those focused on connectivity in the software space, but on the flip side, sectors such as consumer are seeing "a lot of challenges," Lubin added.
Boston Consulting Group's Schneider said he has seen "a couple" of private equity firms actively looking, and there could be some attractive assets, although the finance market has become "very tough."
In terms of general sentiment, Schneider said he has not heard anyone being "particularly optimistic" with regard to the uncertainty. Until there is more clarity, private equity activity is expected to remain quite subdued, something that was unthinkable a month ago as it carried on with its significant run.