The article below is from our BRIEFINGS newsletter of 23 April 2021
At a recent meeting of the Goldman Sachs Asset Management Forum, Mike Brandmeyer, global co-head and co-CIO of the Alternative Investments & Manager Selection Group, and Mike Koester, global co-head of the firmwide Alternatives Capital Markets & Strategy Group, discussed the state of private markets more than one year into the pandemic and how portfolio companies have fared during the crisis.
As economies across the world start to reopen, can you give us a sense of where the private equity (PE) industry stands today?
Mike Brandmeyer: The PE industry is stronger today than it was a year ago, largely due to key structural shifts that have been underway for more than a decade. Traditionally, PE firms had been primarily focused on leveraged buyouts of more mature, low-growth, asset-intensive businesses that were considered undervalued. Venture and growth equity were smaller parts of the market. In the wake of the financial crisis, younger, high-growth tech companies opted to remain private for longer given an abundance of private capital and the massive growth of the software industry. As a result, venture capital and growth equity firms gained market share while the traditional “buy it, fix it, sell it” LBO model waned in popularity. So PE firms shifted to buying more high-growth, asset-light businesses (often with software-as-a-service business models) and growing them with strong management teams. All of that helped to strengthen the average quality of the portfolio companies and their management teams.
So how did PE firms and portfolio companies fare during the pandemic?
Mike Koester: When the pandemic hit last spring, PE sponsors employed lessons learned from the financial crisis very quickly. Sponsors and portfolio company management teams were focused on cutting costs, conserving capital and ensuring there was enough liquidity to bridge them to the other side of the pandemic. Irrespective of whether companies operating in adversely affected industries or in businesses that were accelerated by the pandemic, sponsors were able to be agile and decisive in their decisions thanks in part to their ample liquidity positions and their concentrated ownership models. More broadly, powerful fiscal and monetary stimulus benefited the industry as a whole as central banks supported the credit and equity markets. Because of the aggressive intervention, there were far fewer restructurings of PE-backed companies than expected.
Can you give us a sense of the trends affecting portfolio companies in the private markets?
Mike Koester: Trends that we’re seeing in our portfolio companies are not much different than those observed in publicly traded companies. As portfolio companies work their way through supply chain bottlenecks, they’re experiencing cost pressures through higher freight costs as well as rising wages, particularly in the U.S. where companies are competing with unemployment subsidies and stimulus incentives. Nevertheless, we expect these supply chain challenges and cost pressures to subside. As demand returns, we expect that earnings should exceed pre-COVID levels. We’re optimistic about the outlook for 2021 and 2022. CEO confidence is high as evidenced by their willingness to make investments and acquisitions.
Finally, what’s your view on the level of SPAC activity in the market and how does that affect PE firms?
Mike Koester: SPACs are an important capital market innovation as they provide companies with another way of going public besides traditional IPOs and direct listings. Many companies, including certain high-growth businesses that require a lot of capital to support that growth, are most efficiently funded in the public markets. That said, the traditional IPO path doesn’t make sense for all companies. Going public via a SPAC allows companies to discuss their long-term growth forecasts, a limitation when listing via traditional IPO. For the PE industry, SPACs represent another potential path to liquidity for our portfolio companies.
Mike Brandmeyer: With respect to the level of activity, I do think there are signs of excess—so far in 2021, SPAC launches have already eclipsed last year’s record of 250. Looking ahead, the performance and success of SPACs will be entirely dependent on execution. Winners in the space will likely be the SPACs with experienced sponsors and stronger structures that better align incentives upfront.