Article by Crowe
There has been no shortage of coverage on the deal-making environment (or lack thereof) in the second half of 2023 and first half of 2024. Equally, anyone with a keyboard and an interest in M&A has predicted a warm-up in the second half of 2024, which has reportedly begun to materialize on a few fronts:
- Pitchbook's July update says demand signals for PE-backed leveraged buyout (LBO) deals are favorable, despite a very slow Q2.
- Several banks, including JPMorgan Chase and Goldman Sachs, reported significant Q2 increases within their investment banking divisions, which is a positive sell-side indicator for the second half of this year.
- There are several other reports of increased activity – more mandates, more bidders, more aggressive bid strategies.
- Investment bankers indicate a record backlog of deals ready to bring to market.
- Crowe’s Transaction Advisory deal data indicates modest improvement in the first half of 2024 versus 2023, though it still lags the record activity of 2022 by nearly 20%; consistent with Pitchbook and others, we have seen gains largely driven by private and public companies’ acquisitions and PE-backed add-ons.
The case for second-half-of-2024 improvement: The log-jam breaks, rates cooperate, and PE-backed platform companies fill up the deal pipeline.
- PE funds that want to keep LPs (and GPs) happy and raise their next fund start selling investments to keep DPI in the “green.”
- DPI (distributed to paid-in capital) is the ratio of cash outflows to returns that LPs (limited partners, or investors) are experiencing.
- Maintaining a healthy DPI is crucial for demonstrating success to current and potential investors – a higher DPI suggests that investors are receiving a good return on their investment, while a lower DPI may signal potential issues in portfolio performance or market conditions.
- The GPs (general partners) at many funds who co-invest alongside their LPs are also watching DPI closely – they too want to see some returns from their investments before committing cash to future funds and investments.
- Many PE funds have a significant backlog of portfolio companies whose “vintages” now signal it is time to transact – per Pitchbook, PE owns 50% more portfolio companies acquired between four and six years ago than just prior to the pandemic.
- PE dry-powder (committed funds to be deployed by the fund) remains at a record high but is aging – most PE structures limit the duration of time the GP has to call and deploy committed capital.
The case against: The deal-making environment worsens.
- Rates: Any cuts to the fed funds rate in the second half of 2024 are symbolic, and the private credit funding LBOs doesn’t react quickly.
- Multiples: The buyer/seller dislocation continues as portcos purchased post-pandemic at inflated multiples remain difficult to sell at an attractive multiple; sellers achieved enough liquidity to balance their DPI equation this year by selling equity stakes to secondaries investors or taking on additional leverage through NAV or PIK arrangements.
- Debt providers: The extensive support of PE deal-making by private credit tightens up, which creates obstacles to transacting without rate cuts. Bloomberg wrote extensively in July about potential risks associated with the opaqueness of the private credit market.
What our clients are doing about it:
- Centering on driving real return: Focusing on driving realizable gains in EBITDA – financial engineering aside, driving quantifiable operational improvements will improve the case for realizing a better outcome at sale.
- Re-evaluating portco forecasts: Scrutinizing the portco's forecast mid-hold in light of predictive economic indicators and considering the timing of a sale process.
- Getting the parachutes ready: Being ready to jump through the window of opportunity for the sale of a portco that's reached its “vintage” – having the right management team in place with advisors teed up and ready to go is key to taking advantage of the window.