2020 was certainly an extraordinary year for markets across industries, sectors and asset classes. Private equity was no exception, as leveraged buyout markets seized up in March and April, and buyout managers moved quickly to triage their portfolios, ensure liquidity for underlying portfolio companies and preserve equity value across fund vehicles.
As managers evaluated the risks to their various portfolios, many implemented a “stoplight” approach, classifying each investment according to three distinct buckets. A “red light” distinction referred to heavily impacted businesses, while a “yellow light” distinction consisted of moderately impacted businesses and a “green light” distinction referred to companies that were performing well and even seeing tailwinds due to the virus.
Investment teams dissected each portfolio company’s exposure to COVID-19 by looking at impacts to future sources of revenue, cash flow, distribution channels, product growth and expansion plans, as well as the overall economic environment these businesses would operate in moving forward. Broadly, however, private equity deal activity and deal value skyrocketed in the latter half of the year, illustrating the resilience of the asset class and its ability to weather the impact of the virus head-on.
As shown in the chart above, it is clear that deal activity and aggregate deal value for private equity transactions dipped severely in the second quarter of 2020. In fact, the number of deals executed in Q2 2020 was the fewest since the first quarter of 2013, and aggregate deal value was the lowest since the first quarter of 2016.
But as vaccine development and deployment accelerated, particularly in the fourth quarter of 2020 and the first quarter of 2021, private equity dealmakers went to work. The number of deals executed in Q1 2021 was the highest on record, dating back to 2011, with private equity transactions reporting record deal value in Q4 2020 and again in Q1 2021.
According to PitchBook, add-on acquisitions propelled deal activity in 2020, accounting for 72.5% of all buyout transactions, surpassing 2019’s all-time record. In addition, public listings were the preferred route for the largest exits in 2020, with eight of the 10 largest being initial public offerings or direct listings. As I wrote about in one of my previous Chart of the Week posts, special purpose acquisition companies (SPACs) also played a key role in helping private equity managers facilitate exits and shepherd portfolio companies to the public market.
A few sectors certainly performed better than others. Private equity managers investing in hospitality, travel and leisure, transportation and gaming were hit hard, while firms investing in technology, health care and consumer staples benefited and saw valuations continue to rise with each passing quarter.
Speaking to the resilience and strong performance of the technology sector, particularly software, Thoma Bravo, a software-focused private equity manager, bought Ellie Mae for $3.7 billion in April 2019 and sold it for $11.0 billion to Intercontinental Exchange just a year-and-a-half later in the midst of COVID-19, garnering the title of biggest exit of the year.
Per PitchBook, many of the largest exits in 2020 were either technology companies directly or primarily tech companies operating in other industries such as health care or financial services. Finally, the proliferation and popularity of SPACs in 2020 were a benefit to private equity firms, as many companies looking to go public sought to partner with higher-quality institutional sponsors with deep sector and industry knowledge.
As leveraged buyout markets froze up in the second quarter of 2020, many private equity firms shifted their focus from sales processes and driving exits to triaging their portfolios, shoring up balance sheets and preserving as much equity value as possible. However, as vaccine development and deployment improved, private equity managers executed on a record number of add-on acquisitions, sponsoring blank-check companies (SPACs) and working to exit investments in a more friendly mergers and acquisitions environment.
For limited partners, it is key to conduct due diligence regarding private equity managers’ understanding of the economic environment in which their portfolio companies operate, as well as their ability to pivot the business in order to take advantage of or withstand a shock like COVID-19. Although predicting a global pandemic is impossible, it certainly helps to partner with general partners that operate in mission-critical sectors like technology, health care and consumer staples.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
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