Inflation and rising rates will stifle PE transactions in H2 – Bain

Private equity investors should brace for more uncertainty around inflation and asset valuations in the months ahead after deal volumes slowed in the first six months of the year.

Private equity’s explosion of activity last year is unlikely to be repeated in 2022, according to a report by Bain & Co.

The volume of buyout-backed deals and exits dropped in the first half as inflationary pressures started to hit, the consultancy noted in its Private Equity Report Midyear 2022 report. The deal market started strongly with $512 billion worth of transactions during the first half the year, with the average deal size close to $1 billion.

The picture is, however, looking different in the second half of the year.

“Deal pipelines in many sectors are softening, in technology especially, and debt is becoming more expensive,” the report noted. “Facing losses on loans committed before the slowdown, banks are asking a lot more questions about a company’s exposure to inflation and rising rates, making it harder to close transactions.”

Exits in the first half also slowed down. The value of buyout-backed exits globally fell 37 percent year-on-year to $338 billion as of end-June. Global IPO value, which also includes those backed by PE firms, plummeted 73 percent to $91 billion. Bain’s figures do not include exits in growth equity and venture capital, where the tech stocks rout have the largest impact.

Two European GPs that Private Equity International spoke to in recent weeks expect longer hold periods for their assets, with some funds pre-emptively taking minority stakes in deals instead of majority ones. The GPs likewise noted slower distributions due to a weaker exit market and higher refinancing costs in the months ahead.

Talent also remains one of the main considerations in the high inflationary environment, said a London-based GP.

“How you manage your cost base against the inflationary pressure your employees have – energy and food costs increasing, for example – and what that means for your ability to be able to put through price increases and how accepting your customers area is key concern of ours.”

At this time last year, Bain & Co noted in its half-year 2021 report that the year was setting up to be by far the best year in the industry’s history.

The outlook for the second half of the year looks slightly different across markets, with the effect of rising rates and the decline in tech valuations expected to affect US investors the most. Europe faces the ongoing war in Ukraine and a deepening energy crisis, and Asia will continue to see uncertainty with shutdowns in China. There will be more appetite for South Korea and Japan, Bain noted.

For private equity investors, the focus for the second half is to “help management wring out revenue gains, preserve (and even expand) margins, and manage cash on the balance sheet”, Bain noted. The consultancy recommends that GPs plan for scenarios in their industries, disaggregate price and volume and look for “inflation winners” that can protect their margins.

Here are five key charts from Bain’s report.