Back to podcast

Hi everybody. My name is Pete Witte. I’m the Lead Analyst for Global PE here at EY, and you’re listening to the PE Pulse mini-series on EY’s Nextwave Private Equity podcast. Over the next few minutes, we’ll talk about some of the things that we’re seeing in the market, we’ll talk through some of the major themes from the past year, and more importantly, where we think all of this is going and what it means for you. We’ll talk through our outlook for the coming year and point out a few things for you to keep an eye on. In addition to today’s podcast, we’ve got a great written report as well that talks through a lot of this in more detail and, to see that, you can just visit https://www.ey.com/pepulse. So, let’s get started.

First and foremost, let’s talk about market activity, because about mid-year, we took a look at the numbers and it was becoming very apparent that we’re in the middle of an absolutely massive year for private equity. When we usually talk about total annual PE investment activity, we’re used to seeing something in the $400B to $500B range; $1.2T, that’s what we saw last year. So just a massive upswing from 2020, and really any year before this. You tend to think of 2006-2007 as the high watermark for private equity when we saw all of these huge club deals; well, last year’s activity really just blew that away. And the interesting thing is that while we did see certain themes throughout the year, it wasn’t just one or two things that were really driving the market; this was truly a broad-based upswing across the market. From a geographic perspective, the Americas were up the most – 125%, but we also saw significant increases in Europe and Asia. From a size perspective, we saw more mega deals than we’ve ever seen before but, at the same time, the middle market was very active as well, so there really was something for almost everybody. From a sector standpoint, obviously tech has been a powerful theme here for a number of years. That’s something that’s been accelerated, about 30% of the total capital deployed last year was in that space, but we also saw more interest in spaces like consumer products and consumer services: about 25% of the total deal value there.

We continue to see a lot of activity in financial services, especially in the insurance space, so both the large mega deals in the insurance space that are really focused on growing firms’ assets under management; but also, some more growthy-type investments. Spaces like FinTech, InsurTech, where private equity firms, they can come in, they can back a solid platform and the technology, help it grow with the right kind of capital and operational support and so on. But all in all, just an incredibly busy year for anybody involved with private equity. It certainly was for us here at EY.

Now, speaking of growth capital and growth mega fund, they might sound like a misnomer. Generally, when we think about these types of funds, most folks are thinking about relatively small pools of capital, they’re seeking out minority positions and smaller, higher growth stage companies; but what we’ve seen in recent months, in particular, is this new generation of funds that are taking the strategy in new directions. In total, growth equity funds raised about $102B last year. That’s up just over 50% from 2020, and it’s up about 75% from the five-year average for growth equity fundraising. And I think there’s a few things that are really driving the trend here. For one, we’ve seen well-established growth equity managers raising bigger funds than they ever have before. You saw managers that had raised $8B a couple of years ago, they’re coming back into the market already, they’re upsizing their funds to the $10B-$12B range. And then, at the same time, you see a lot of funds that are launching dedicated growth capital strategies for the first time, especially with a lot of the buyout funds where maybe they’ve been doing some growth investing out of the main pool for a while, and now they’re breaking that out into a separate dedicated fund. And I think that’s reflective of a few different things. For one, businesses have become so expensive across the board that, as a PE firm, there’s just really not much of a continuum anymore between growth and value. And firms are saying, if we’re going to pay up for assets like that, they weren’t going to do it for companies that are growing 20%-30% a year, whatever it is, versus 7%-8% a year, because they’re all priced high. The other is that as we’ve seen, the traditional buyout space has just become more crowded in recent years. The deals are all intermediated. They’ve got a lot of buyers lined up for each asset. It’s hard to have an edge that way. In the growth space, you can leverage that sector expertise, there’s more room for creative sourcing and structuring. There’s just a lot more headroom to come in and add some differentiated value.

Finally, I think there’s just this persistent question around how much more runway do tech deals have to go? I think firms are looking at the market right now. They’re looking at the way that technology is pervasive across industries, how software is enabling all of these new pathways for growth, not just in the tech space, but everywhere (healthcare, consumer, energy, financial services). And I think firms are saying big picture - we’re still in the early stages of the tech revolution, and so they’re investing behind what they see is sort of this once-in-a-lifetime secular tailwind. So, I don’t think we see any measure of abatement there, and I wouldn’t be surprised if we see more vehicles come to market in the coming months.

Which takes us up to our outlook for the coming year, and the wild card here is inflation and the policy responses to that. When you think about PE and the period in which it really came of age, we had really low interest rates, we had low levels of inflation, we had very dovish central banks. and now, we’re headed into this period with potentially higher rates, higher levels of inflation and so on. And I think, if you asked a lot of the funds, six or nine months ago, whether we’d still be talking about inflation, in January, a good proportion probably would have said no. It’s proving to be a lot more persistent than a lot of folks first thought. Right now, for example, in the US, immediate inflation expectations for next year are somewhere around the 6% mark, and most folks are obviously predicting some monetary tightening over the course of the year as well.

So, what are the impacts for private equity? Clearly, a lower cost of capital has been a strong tailwind for new deals, but it’s also attracted competition at the same time, not just from other private equity firms, but from corporate acquirers, family offices, and so on, and all of that has driven up valuations. 2011 average LBO was acquired at a multiple of just under nine times EBITDA. In 2021, the average LBO was done at a multiple of about 11 times EBITDA, and it’s not uncommon for some of these growth deals to trade at well over 20 times earnings. So, I think while higher rates would certainly increase those financing costs, the negative impact of that should be offset, at least to some degree, by a decrease in entry prices. And I think what we’re hearing from the market is that the vast majority of private equity firms are underwriting some measure of multiple contraction into new acquisitions based on an assumption that valuations are going to regress to those historical means at some point during the year. Maybe more interesting, and less certain, is the impact on fundraising. And I think while higher rates are probably pretty unlikely to impact fundraising over the short term; over the long term, could higher interest rates precipitate some sort of rebalancing in the portfolios? Private equity is a prime beneficiary of lower rates, because it drove pension funds and other types of investors into alternative asset classes. Now, my view is that private equity is sufficiently established at this point, that things likely wouldn’t change that much, but it’s certainly something to watch: if rates move significantly higher than they’re expected to right now, or if they stick around for a lot longer. So, it’s going to be another interesting year.

Overall, we’re looking for continued activity on all fronts. Whether or not that continues at the same pace as 2021 is an open question and will be highly dependent on the macro environment. Thanks everybody for listening. We’ll be back next quarter with another update and, until then, take care. 

Back to podcast