- Two of private equity’s top advisors — Bain & Co and McKinsey & Co — laid out the state of PE investing in recent reports and interviews with Business Insider.
- Private-equity firms are scrambling to save portfolio companies in vulnerable industries, calling in money from investors and re-writing ‘worst case scenarios’ for investments.
- PE shops are already talking through alternative exit strategies with corporate execs of the companies they own and doing daily check-ins to examine financial performance in real-time.
- Brenda Rainey of Bain & Co said that as bank lending stalls out, venture capital and growth equity investments will hold up much better than buyouts that depend on leverage.
- Visit BI Prime for more Wall Street stories.
With dealmaking put on pause, private-equity firms are busy shoring up cash at existing portfolio companies — often calling on investors to immediately fork over capital they once promised to help fund them — while re-writing worst-case scenarios for the current environment.
The frenzy has given an edge to the largest private-equity firms with huge teams of operating partners, or executives who work alongside management teams to make operational changes including hiring, firing, and rejiggering of business lines.
And they’re using real-time data to inform decisions about what to do next, according to two of the largest private-equity consultancies, McKinsey & Co. and Bain & Co.
“Realistic assumptions now … involve a downside two or three times worse than previously assumed,” said McKinsey in a report released on Friday, based on 12 interviews it conducted with private-equity executives in Asia, Europe and North America.
“If the old playbook projected a downside scenario with revenues falling by 15 percent, multiply that by three to envision a 45 percent decline,” the report said, referring to new calculations PE execs were drawing up to project business prospects for their investments.
The report, written by McKinsey partners Ivo Naumann and Jason Phillips, comes as PE portfolio companies, ranging from casinos, parks, hotels, along with entertainment and retail companies, have been slammed with a dropoff in revenue due to the coronavirus, with no clear sign of how long the downturn will last.
New York Governor Andrew Cuomo said this week that the state’s stay-at-home order would extend until at least May 15 as US President Donald Trump considers reopening the economy. The past four weeks alone have seen more than 22 million Americans put out of work.
For private equity, a business that involves managing assets for profit, the crisis has led to sleepless nights for executives who are trying to figure out how, in the worst cases, to stave off the collapse of their most vulnerable companies.
AMC, the large movie-theater chain that’s shuttered its locations because of the coronavirus, is looking to raise $500 million of new debt. One of its major investors is China’s Dalian Wanda Group, a private-equity firm. U.S.-based Silver Lake made a $600 million investment of convertible debt in AMC two years ago.
Capital calls
In many instances, private-equity firms are calling on their investors for money to help alleviate portfolio companies’ financial woes, according to Brenda Rainey, a consultant with Bain & Co.
Between mid-March and today, there has been a 58 percent uptick in so-called “capital calls” reported by investors in private-equity firms, otherwise known as limited partners, or LPs for short, according to a survey of LPs from the Institutional Limited Partners Association.
Capital calls happen when a private-equity firm needs to use investor dollars to support an investment or close a deal. When this happens, PE firms call in money that has been previously pledged to them by their limited partners.
But if there’s too much capital called at once, it can cause liquidity problems for a limited partner — often times insurance companies, pension funds, and sovereign wealth funds.
“We do see LPs more often than not having increased capital calls, despite the fact that the deal market is down,” said Rainey.
“Much of that capital is invested in existing portfolio companies where there is a negative cash flow situation.”
Rainey said that, depending on how long the crisis continues, companies could need more cash from existing investors to support the business.
PE firms scramble to aid portfolio companies
To assess where PE firms should deploy operational resources, firms are relying on a traditional red, yellow and green traffic-light system to mark their portfolio companies, with each color indicating the level of engagement and support each business needs.
“Acknowledging the primacy of cash in sustaining businesses, firms have requested 13- to 26-week cash forecasts from portfolio companies to better manage liquidity,” McKinsey said in its report.
McKinsey said some US firms are seeing downside scenarios that ranged from a more gradual recovery beginning in the third quarter, to a “grim scenario with doors closed through the end of 2020.”
“Firms with more experienced operating groups often asked executives to incorporate triggers into their scenarios so that certain financial outcomes would require leaders to take specific actions to improve their cash positions,” the report said.
Meanwhile, communication has ramped up between PE firms and portfolio companies.
Talks that were once held in monthly or quarterly check-ins have shifted to weekly or even daily calls. On each, financial performance data is analyzed, McKinsey said.
Rainey, the Bain consultant, said PE firms are looking at everything from credit card data, to industry-wide consumer behavior, to data from mobile devices, to track the financial performance of their portfolio companies — a key difference, she said, from what happened in the last financial crisis.
“Whether you are investing in debt or equity, there is a lot of engagement and usage of data analytics, again, to track changes on a daily basis, to help inform investment decisions,” she said. “It’s a big and powerful change this time versus last.”
Some acquisitions are still taking place
Deal making, overall, is slipping, but some opportunistic acquisitions are taking place.
Rainey said that up until February, two-thirds of buyouts were done with debt levels of more than 6 times EBITDA, which she sees dropping off in the future, playing to the benefit of investments that have traditionally used lower leverage.
“We expect this time around, venture capital, growth and pure equity investments will tend to hold up much better than buyouts that depend on leverage,” said Rainey.
“I don’t think we are seeing bank lending freeze but it is certainly stalling and it will take some time to work out how to assess risk today to determine how much to lend and at what price,” said Rainey.
Right now, fewer deals are happening but some companies are being opportunistic, according to M&A lawyers.
Brian Hamilton, a partner with Sullivan & Cromwell, said PE firms, family offices, and pension funds are thinking opportunistically about doing deals.
“We had a large family office agree to buy a business from a distressed seller in late March,” he said. “Their ability to do the deal without needing to get debt financing gave them a huge edge in the process. We’re also running a sell side auction for a mid market, founder-held business now and last week got initial indications from eight different sponsors.”
“So folks are looking at transacting, but there is no doubt that it is a brutal environment and it takes both creativity and aggressiveness to get things done right now.”
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