1 Mid-market managers eye post-pandemic deals
US mid-market deal volume and deal value have been on an upward trajectory since 2014 and 2016, respectively, climbing to 3,529 deals with a total value of $530.8 billion last year, according to PitchBook data. The first quarter of 2020 appeared to continue this trend, with deal volume growing by 14 percent and deal value rising by 31 percent year on year. Yet these figures in large part reflect deals finalised or negotiated before the US felt the full force of the pandemic and lockdowns began to be implemented.
As the extent of the covid-19 crisis and its economic fallout became apparent, mid-market firms turned their attention to portfolio company support, utilising their expertise and the tools available to them to help navigate businesses through acutely challenging circumstances. Now, there are signs that bandwidth and appetite for new deals are gradually increasing.
Jon Marston, partner at advisory firm WilliamsMarston, says: “From March through to mid-May, support took up a lot of time. But as June approached, more time was spent scouting new opportunities – largely with projects or deals that were either already in a holding pattern or in the pipeline during Q1. As we’ve moved into Q3, however, it appears that the deal market is coming back to life.”
Businesses in sectors that have been less negatively affected or even prospered during the crisis, such as technology, could make for attractive targets, particularly as the accelerated shift to digital looks to be a trend that will remain long after lockdown restrictions ease.
Meanwhile, companies that have not been as well positioned to weather the impact of the pandemic may present opportunities at discounted prices. Indeed, according to the latest Emerging Manager Survey, conducted in May-June by sister title Buyouts in partnership with Gen II Fund Services, 91 percent of emerging manager respondents expect to be more active when it comes to dealmaking in order to take advantage of low asset valuations.
Marston says: “For businesses that have thrived, they will likely have multiple suitors. For those that have struggled, but pivoted, buyers will likely be very interested. For businesses and sectors where pivoting was not an option, there could be significant roll-up activity as buyers seek to expand their own market share at potentially distressed prices.”
2 GPs explore alternative capital and communication routes
Given the challenging dealflow environment over the last few months, GPs have been looking at alternative means of deploying capital, such as add-ons, minority investments and private investments in public equity.
There had already been 162 PIPE deals worth a total of $16.9 billion in the US by mid-July, according to PitchBook. This compares with 263 such deals at $13.8 billion over the course of 2019.
As Muhammad Azfar, CEO and managing partner at Auctus Capital Partners, tells sister title PE Hub: “Every year PE firms need to close on a certain amount of deals. If the pipeline looks dry, we need to look across [sectors] quickly to put capital to work.”
And it is not just when it comes to putting capital to work that GPs have turned to alternative or more creative solutions.
Mid-market managers have explored a range of communication methods to support portfolio companies and update LPs. For example, MidOcean Partners hosted weekly portfolio-wide calls to share best practices around specialisations such as marketing and HR, and TA Associates held its annual LP meeting in May virtually.
“We adapted by shipping recording equipment to the homes of each of the TA partners, so that each of us could record our presentation sections in advance. I believe that we made the best of the situation,” says Mark Carter, managing director at TA Associates.
3 First-time funds falter, but LP appetite remains
US mid-market fundraising has been on the up over the last few years, growing gradually from $102.7 billion in 2016 to $107.9 billion in 2018, before surging to $134.3 billion last year. Unsurprisingly, 2020 has seen a slowdown, with capital raising dropping by 12 percent year on year to $24.8 billion in Q1, according to PitchBook data. Interestingly, however, the mid-market accounted for almost 58.7 percent of US private equity fundraising in Q1 2020, up from 47.3 percent in full-year 2019.
Perhaps hindered by a lack of established relationships and the due diligence hurdles presented by travel restrictions, just one first-time fund was raised in Q1 2020, compared with seven in the same quarter last year, according to PitchBook. These difficulties are echoed in the aforementioned Emerging Manager Survey, in which nine in 10 managers surveyed said covid-19 will make fundraising more difficult, with 26 percent expecting it to be ‘a great deal’ more difficult. The majority of respondents expected to delay the launch of new funds by a few months (44 percent) or longer (22 percent), while 7 percent have decided against launching a new fund entirely.
Yet LP appetite for emerging managers does not appear to have dissipated; 79 percent of institutional investors participating in the survey report that recent market turmoil has not prompted them to change their allocation to emerging managers, and 89 percent said they would back a debut private equity or venture capital fund. “Supporting emerging managers often comes with strong alignment, a more conviction-weighted investment approach and the opportunity for high returns,” Derek Schmidt, director of private equity at investment consultant Marquette Associates, tells Buyouts.
4 Mid-sized companies’ projections pick up
There is no denying that many mid-market companies have been badly hit by the fallout from covid-19, but data from the National Center for the Middle Market points to the road for recovery ahead. In NCMM’s March covid-19 survey, 70 percent of mid-sized companies said they would pull back on growth initiatives over the next 12 months.
However, in NCMM’s Q2 2020 Middle Market Indicator survey, conducted in June, 37 percent said they were very or extremely likely to enter new markets in the next 12 months. And while 43 percent said in March that they expected covid-19 to have a major negative long-term impact on their 2020 projected revenue, just 23 percent said the same in June.
The Q2 survey put the projected 12-month revenue growth rate for the mid-market at 2 percent, and the employment growth rate at -0.2 percent. But expectations among private equity-backed businesses are more optimistic, with a projected revenue growth rate of 3.4 percent and an employment growth rate of 0.7 percent over the next 12 months.
In the words of NCMM executive director Thomas A Stewart and NCMM managing director Doug Farren: “Mid-market companies have taken a gut-punch but are starting to dust themselves off and think about how to get back to the work of driving the US economy.”