With leverage levels surpassing those of the global financial crisis, speakers at May’s PEI Operating Partners Forum Europe were increasingly focused on downside risk.
What – if anything – did the private equity industry learn from the 2008 crash? Speakers at the conference sat down with Private Equity International to give us their verdict on whether the industry is prepared for another downturn 10 years on from the last one.
Amanda Good, partner at HgCapital:
I think those capital structures will inevitably change at some point. I think it’s just we’re at all-time high levels of debt again and that’s just not maintainable.
Fredrik Henzler, co-head of industry value creation at Partners Group:
If you look back at leverage levels, if you look back at prices being paid pre-financial crisis, I think we are back or even higher than we were at that time.
[On] the investment side, we also as an investor will say, well, while the leverage level is the same, it’s cov-lite and the interest rates are much lower. So it’s a much easier burden to bear – five times or six times leverage – than it was in 2007-08.
Ewa Bielecka Rigby, head of value enhancement at LDC:
I think that there is a bit of mismatch between the quality of assets we acquire and the price paid for them. So I think in a year or two we may see the next wave of a lot of restructuring. However, the money you can borrow on the market is still very cheap so I think it hides quite a lot of problems.
Mike Mills, partner at KPMG:
We are involved more and more in recession-proof diligence if you like, so looking at businesses particularly around their cashflow and how could they squeeze any additional working capital out. So I think that private equity houses are certainly more focused than they were 10 years ago this year.
Whether they are going to be able to dodge a potential recession or financial crisis, if it ever happens I don’t know, but they are certainly being more active than they were 10 years ago.
What is absolutely true is that there is no investment committee discussion or no discussion in the deal team without discussing what does the downside case look like and what does a recession case look like, and quite often we take the development of an industry or a company or of competitors during the Great Financial Crisis as a proxy to what could the downside case in drop in revenue EBITDA cashflow look like in a worst-case scenario.
I think the major lesson has been that you can’t always expect that Plan A will happen and so, especially when you’re looking at organic revenue growth, that budgets will be there in your end customers, that those companies will be able to spend more and more next year and the following year if their budgets get cut.
So you have to really think about, if you’re going to drive these plans, what happens when there might not be as much money to spend on your product or service. How do you continue to go for a Plan B, which can be very different than what your original investment case looks like?