Private equity deal-making to increase in 2023 as industry fundamentals remain strong

Deals fell sharply last year to leave investors with record $3.7 trillion in dry powder, report says

A Wall Street sign outside the New York Stock Exchange. Global IPO activity fell sharply last year, affecting private equity exits from deals. Reuters

Global private equity deal activity is expected to pick up pace in 2023 after a sudden drop in the second half of last year and is set for strong long-term growth as fundamentals of the industry remain strong, a report has said.

Private equity companies around the world ended last year with a record $3.7 trillion in dry powder, but investors focused on risk management and mitigation, setting themselves up to get out of the weaker period, global consultancy Bain & Company said in its annual Global Private Equity Report on Thursday.

The rapid reversal in deal-making that began in the second half of last year forced a 35 per cent drop in global buyout value, excluding add-ons, to $654 billion.

The overall deal count also tumbled 10 per cent with 2,318 transactions completed in 2022.

The slowdown follows record highs in 2021, when the value of completed deals topped $1 trillion, capping a 12-year increase for the private equity industry.

“So far this year there has been a continuing slowdown in the action, but private equity’s long-term appeal to investors is secure,” said Hugh MacArthur, chairman of the global private equity practice at Bain & Company.

“As deal activity begins to pick-up in 2023, the industry continues to be well positioned for long-term growth.”

There is potential for the private equity sector to become even more appealing for investors frustrated by the limitations of public markets.

The sector’s underlying fundamentals remained unaffected and resilient, with 2022 being the second-strongest year in private equity’s history, the report said.

Economic uncertainty driven by rising inflation, sharp interest rate increases and geopolitical risks after the start of the Ukraine war contributed to the sharp decline in deal activity, the report said.

The reluctance of banks to lend to large leveraged transactions from the middle of the year as interest rates rose also dictated how deal-making unfolded in 2022, with leveraged loans across the US and Europe falling 50 per cent to $203 billion.

“The result was a decline in the sort of large, high-leverage transactions that have for years buoyed deal value so that average deal size fell by 23 per cent over 2022 to $964 million after having climbed steadily every year since 2014 to achieve a record high in 2021 of $1.2 billion,” the report said.

The 2022 private equity industry slowdown also hit growth equity and late-stage venture investment — segments that previously rose sharply. Overall deal value in the segments dropped 28 per cent to $644 billion.

Deal exits fell even more than investment activity, with buyout-backed exits dropping by 42 per cent to $565 billion, while growth equity exits plummeted by 64 per cent to $312 billion.

“The falls reflected the complete shutdown of the IPO [initial public offering] market amid sharp falls in public equities, as well as a drop in sponsor-to-sponsor deals by 58 per cent,” the report said.

“Sales to strategic buyers were higher than the five-year average, largely due to corporate earnings’ resilience, but still ended 2022 some 21 per cent down on the prior year.”

Global economic growth is slowing amid inflation that hit a 40-year high in the US and Europe. In October, the International Monetary Fund cut its global economic growth forecast to 2.7 per cent for 2023, 0.2 percentage points lower than its July forecast.

The IMF also warned of a 25 per cent probability that output could fall below 2 per cent in 2023, the weakest growth since 2001, except for the 2008 global financial crisis and the acute phase of the Covid-19 pandemic.

Central banks around the world have increased their benchmark policy rates to curb inflation.

The US Federal Reserve has increased its benchmark rates and more raises are expected as it aims to bring inflation down to its target range of 2 per cent.

Fed Chairman Jerome Powell has indicated that the central bank's interest rates could exceed its initial estimates.

Despite continued economic turbulence and the rate increases, Bain said “current conditions are nothing the industry hasn’t dealt with successfully before”.

Clear strategic “sight lines”, rather than economic conditions, are what will “bring energy back to deal-making” even if interest rates remain higher for longer, the consultancy said.

“Despite all of the past year’s declines in deal-making, exits and fundraising, Bain’s analysis suggests the long-term outlook for private equity remains one of resilience and expected resurgence even though a turnaround in macro conditions is impossible to predict with accuracy,” said Gregory Garnier, partner at Bain & Company.

Despite a 10 per cent annual drop in industrywide fundraising to $1.3 trillion, Mr Garnier said, “the outlook for PE fund-raising remains exceedingly bullish”.

“In that market context, institutional investors such as Middle East sovereign wealth funds are a source of stability and play an increasingly important role globally both as a LP [limited partner] but also as a direct investor,” he said.

Individual investors and their wealth are expected to be the “new great growth engine" for the private equity industry, he said.