The pre-pandemic era was a quite different one for the world of private equity. Leveraged buyouts (LBOs) of undervalued firms that showed low growth, were asset-intensive, and more mature, were in focus. The market gave relatively little space to growth equity and venture capital. Bulls ruled, and PE firms were able to raise huge sums, with enormous amounts of dry powder gathering. There were enough people who believed assets were highly overvalued, and growth was largely seen only in specific areas such as healthcare and technology.

Pandemic effect on private equity

Valuations were duly tempered but in quite an unforeseen way. The impact of the pandemic on private equity was seen in a huge economic shrinkage, where businesses lost billions of dollars off their valuations. Government-mandated business closures and stay-at-home orders decimated hospitality and retail, with similar effects on leisure and travel.

The impact is likely to be different from that of previous recessions and other displacements. There are second-order and longer-term effects on business policies and operations, consumer behavior, and local and national policies. Central banks have injected huge sums into the markets, far more than in the decade-ago crisis. This in turn has meant that equity markets were relatively quick to recover from the initial shock. PE sponsors and portfolio management teams were quick to trim costs, save capital, and provide sufficient liquidity. Along with concentrated ownership, this helped them to be agile and decisive irrespective of whether their portfolio company was in a sector that was accelerated or adversely affected. PE-backed companies saw far fewer restructurings than might have been expected.

Sectoral impacts

Private equity firms saw significant sectoral differences as a result of the pandemic. Funds focused on real estate found the going tough, and business dried up in hospitality and retail.

Deals tended to be on assets that showed strong resilience to the downers from COVID-19. Healthcare, life sciences, and technology investments continued the growth seen in stronger economic times. Online and technology-based solutions were what businesses turned to in order to maintain continuity of operations as well as what state-private partnerships looking to combat the virus turned to, which is why the interest from PE and VC investors is not surprising. This has often been at the cost of deals in other sectors, and transactional partners have remained very busy.

Trends affecting portfolio firms

Going into the pandemic, PE firms had about USD 5.7 trillion in assets under management (AUM). Of this, over 95 percent was concentrated in 20 sectors and subsectors; of this, six sectors – business and professional services, energy and utilities, healthcare, industrial equipment and machinery, real estate, and software – had more than half the total AUM. Healthcare and real estate in particular have displaced hospitality, travel, and media from the top six sector list.

The impact of the pandemic on private equity portfolio firms was not so different from those that are publicly traded. Bottlenecks in supply chains meant that portfolio companies worked through cost pressures from higher freightage costs and rising wages, the latter more pronounced in economies where stimulus incentives and unemployment subsidies were high. With demand returning by and by, earnings should soon match and exceed pre-COVID levels in several sectors.

The reaction from private equity firms

PE firms have been adapting to the crisis, salvaging the adversely affected parts of their portfolios and tapping into new trends where they could place bets. Post-pandemic markets call for a look away from the ephemeral toward the sustainable. Tech firms that are younger and growing well are opting to stay private for longer, given the abundant private capital and strong sectoral growth. PE firms have consequently moved toward buying more asset-light and high-growth companies and growing them further with strong management teams.

Niti Sharma