‘Novel strategies’ being used as financing withers – PwC

Unrelenting market volatility likely means a continued financing crunch for private equity dealmakers in the future, but PwC says market conditions are creating opportunities for innovation.

A new report from the consultancy predicts that GPs will have an easier time with dealmaking in 2023 after a plunge this year.

“With record levels of dry powder (US PE holds $1.1 trillion), we expect more creative approaches to deploy capital (minority investments, all-equity deals, private placement of debt) and a broader recovery in activity either as inflation is tamed or asset valuations are sufficiently depressed,” says the report.

Market disruptions will persist, and may “herald a shift in to a more challenging value-creation environment,” PwC says, and firms will need to focus on critical value creation drivers like “digital, talent and ESG.”

The “old playbook,” the firm says, is “rapidly becoming insufficient.” Cost takeout and inorganic growth through acquisitions won’t be enough, and PE firms will “need to dig deeper for value creation.”

But deals will get done, PwC expects. How?

“We’re already seeing novel strategies to deploy capital despite the financing crunch,” the firm says. “Examples include minority deals (typically not requiring refinancing), all-equity deals (which avoid the debt issue entirely) and private placement of debt (to bypass the more challenging syndicated markets).

“These strategies will support continued capital deployment as funds await more general market normalization.”

What will drive the rebound

Corporate divestitures are expected to drive a rebound in 2023 after a 22 percent decrease in deal volume in the second half of 2022, compared to 12 months earlier, PwC said. Public companies are facing challenges and declines in valuations that will force a “renewed focus on capital discipline and, in some cases, wholesale reevaluation of the benefits of public versus private ownership,” the report said.

This shift in approach will also prompt them to undertake strategic scrutiny.

“Public companies are identifying opportunities in their portfolios for closure, divestment or investment,” PwC said. “They need to maximize strategic alignment, prune underperforming business and, in some cases, raise cash.”

PwC says a major theme in the expected deal rebound will be public-to-privates and carve-outs as valuations continue to decline and corporates look to streamline their businesses.

“We also expect to see continued focus on diversification from traditional PE to other asset classes spanning credit, infrastructure, real estate, impact and others – with potential for some investors to incorporate multiple investment strategies on a single deal,” PwC says. “Traditional LBOs will continue – particularly in the middle market – though we expect their dominance to wane.”

The firm also notes that PE-owned portfolio companies will be looking to deleverage and to hive off businesses that are underperforming.

PwC pointed to the current interest-rate climb as a driver. It stated that companies “are looking to trim underperforming businesses and raise cash to alleviate pressure from higher-interest debt and the resulting impact on share prices.”