MARKET ANALYSIS
Welcome to the inaugural Private Markets Update from McDermott Will & Emery’s
multidisciplinary team. This Report highlights developments in the European private markets, covering the issues that matter to investors in alternative assets. Touching on themes as diverse as predictions for fintech, transatlantic restructuring trends and aligning price expectations in the German Mittelstand, we review what we learned from markets shifts in 2022 and share predictions for 2023 and beyond. To kick off, we crunched the numbers to bring you the “10 Trends To Track.” This is our pick of last year’s themes that tell the story of where the market is today and where it might be going. As the private markets prove more adaptable, confident and robust than their publicly traded contemporaries, we believe the following trends will tell the story of the year ahead, and these data points should be high on the agenda of all market participants. MARKET ANALYSIS TREND 1: PRIVATE EQUITY HAS MORE CONFIDENCE THAN STRATEGICS TREND 2: EUROPE AND THE US WILL DOMINATE GLOBAL DEAL ACTIVITY TREND 3: HEALTHCARE, TECH, INFRA AND ENERGY TRANSITION ARE THE SECTORS TO WATCHAs uncertainty compounded by record inflation, rising interest rates, geopolitical unrest and banking volatility rocks the M&A markets, it is private equity buyers that stand ready to kickstart the recovery in dealflow later this year. With assets in their portfolios ripe for sale and dry powder on their books that needs deployment, we can expect private markets to fuel an uptick in transaction volumes that will likely start to take shape after the summer. At the start of 2023, private capital held more than $3.7 trillion in dry powder globally, setting a record for the previous 12 months with buyout funds taking the lion’s share, according to Bain & Company. In uncertain times and facing a challenging macro and geopolitical climate, now is not the time for investors to take risks on newer and emerging markets. Private capital is likely to revert to more conservative strategies in the years ahead, fuelling predictions that it will continue to be the US and Europe that will dominate deal activity and where private funds will put most capital to work. In 2022, global buyout deal value dropped by more than a third as banks backed away from large transactions, but the drop-off was less significant in Europe and North America than it was elsewhere. In recent years, private markets investors have shown increasing favour towards resilient industry sectors better placed to ride the economic headwinds that we are now enduring. Healthcare, business services and software deals have increasingly dominated both private equity and private debt investing since the outbreak of COVID in 2020, and as we move into 2023 we see infra and energy transition similarly grabbing a growing share of private capital. Data from PitchBook shows the capital invested in B2B, energy, healthcare and information technology combined jumped to $847 billion in 2022, up 12% on 2019.
06 \Private Markets Update 2023 / 07Private Markets Update 2023 TREND 7: INVESTORS WILL GRAVITATE TO ESTABLISHED LARGE FUNDS TREND 6: DIRECT LENDERS WILL BENEFIT FROM THE ECONOMIC HEADWINDS Fundraising was more challenging for private funds in 2022 than it has been for a long time, dropping 11% globally across private markets, according to McKinsey & Company. But in turbulent times, nervous LPs continued to channel allocations towards bigger players with established track records: funds greater than $5 billion raised a record $445 billion last year, 51% up on 2022, while funds smaller than $1 billion raised just $349 billion, down 31%. In PE, the largest 25 managers raised 42% of the global total, the highest annual share since 2013. With most direct loans pegged to floating-rate pricing, coupon payments are increasing as interest rates rise and direct lenders are simultaneously benefitting from widening spreads driving up the expected yields on new loan issuance. With leverage levels coming down, equity cushions strengthening, documentation getting more lender-friendly and distress in the liquid credit markets allowing for market share gains in Europe especially, private credit funds are set to do well. That perhaps explains why private debt fundraising hit an all-time high of $224 billion in 2022. TREND 4: PUBLIC-TO-PRIVATES AND CARVE-OUTS GATHER MOMENTUM TREND 5: BOLT-ONS WILL KEEP SPONSORS AND LENDERS BUSY As public market valuations take a hit and large strategics grappling with squeezed margins seek to streamline their businesses, opportunities abound for private markets to capitalise on both take- privates and carve-out deals. With private equity’s deep pockets and private credit’s ability to deliver flexible finance, we expect these two deal types to feature heavily in the M&A rebound when it comes. Data from S&P Global shows take- privates typically account for about 20% of private equity deal value globally, but that doubled to about 40% in 2022 and accounted for about 70% of private equity’s deal value in the first three months of 2023. Add-on deals have consistently grown in popularity among private equity firms over the past decade, increasing from 49% of total buyout deal count in 2009 to 72% of all buyouts globally in 2022. In a challenging M&A market, when exits are harder to execute, industry roll-ups and bolt-on deals represent value creation strategies that can capitalise on cost-orientated synergies and accelerate expansion into new markets. Add-on transactions also keep PE deals busy and continue to deliver fee income for private credit providers at a time when platform acquisitions are fewer in number.
08 \Private Markets Update 2023 / 09Private Markets Update 2023 TREND 8: PRIVATE CREDIT WILL BE ON THE LOOKOUT FOR SPONSORLESS DEALS TREND 9: THE SECONDARIES MARKETS WILL THRIVE... TREND 10: ...PARTICULARLY FOR PRIVATE DEBT Sponsor-backed M&A continues to comprise the backbone of European private debt deals, accounting for 85% of transactions in the UK in Q4 2022 and 84% in the rest of Europe, according to Deloitte data. But bilateral sponsorless deals that involve corporate borrowers interacting directly with direct lenders outside of a buyout scenario are increasingly seen as both more lucrative and more interesting for debt funds, many of whom are strengthening on-the-ground sourcing capabilities across Europe to tap into non-sponsored opportunities. With challenging public markets and sedentary M&A activity, private equity firms struggling to sell portfolio companies and facing longer hold periods have turned to the secondaries market in increasing numbers in recent years. With GP-led secondaries and continuation funds offering LPs much-needed liquidity, GPs accounted for 30% of secondary market sellers in 2022, according to a Setter Capital survey. More than a third of participants in that survey felt meaningfully more GPs coordinated tender offers or attempted to liquidate or restructure older funds in 2022 compared to 2021, and 42% felt a materially higher number of GPs sought staples last year than they did in the year before. While the secondaries market overall saw volumes fall in 2022 in the face of broader macro uncertainties, credit secondaries enjoyed another record year. According to secondaries firm Coller Capital, the trade in secondhand stakes in private debt funds hit $17 billion in 2022, more than 30 times the total in 2012. At the current rate, the value of secondary deals could hit $50 billion by 2026, the firm predicts. Volatility in the past few years has driven heightened demand for liquidity on the part of both GPs and LPs, leading credit secondaries to balloon as both an investment strategy and a tool for delivering liquidity solutions. The denominator effect that left some LPs overweight on private assets simply because of falling valuations in the public markets has further fuelled activity in a market predicted to keep growing at pace in the coming years.
