Data & Analysis

Private Equity Partnerships in Tough Times

P Epartnerships

On Monday, January 27, the TSX closed its worst day in four months. In the same week, all eyes were on the city of Wuhan in China where officials had just ordered a quarantine for the entire city. These seemingly drastic measures shook the public markets into a tailspin; the record bull market run was coming to an end.

Many thought that this would be contained to that part of the world. However, also that week, Canada’s national health officials had confirmed our first two presumptive cases of coronavirus.

Over the last 12 weeks, we have witnessed wild volatility. Both publicly traded and privately held companies have had to come to grips with identical challenges: changing market conditions, evaluating workforce need and managing cashflows. The stock market has been the barometer for investor and public sentiment for publicly traded corporations. Will the impact on private companies in the longer run be different than their public counterparts? That remains to be seen.

David Turnbull, Head of Private Company Advisory, Capital Markets Group, Manulife Securities says that while liquidity challenges and attitudes impact both public and private companies, private capital is often deployed as patient capital with direct engagement in the business and may be less exposed.

Business valuation must be considered on a case by case basis. Private markets may re-price their investments less frequently and base values on intrinsic measures. To that extent, private markets are less exposed to real-time volatility and behavioral trading of the public markets. However, irrespective of whether the investment is public or private, investors continually adjust their expectations for forecasted free cash flow impacting current valuations.”

While liquidity has been the first challenge faced by many Canadian businesses in this crisis, the economic landscape in the months ahead remains uncertain. The support of a private equity partner can be of invaluable support to navigate these unprecedented times.

In fact, on January 27, our CEO, Kim Furlonghad just published an op-ed about how private equity fuels the growth of SMEs and also is the bridge that ensures survival in times of transition.

Furlong argued that PE partnerships are more than a simple injection of capital” and that they bring perspective, industry expertise, strategic insights, governance and enough distance to see the bigger picture, while being close enough to oversee operations and how the strategic plan is implemented.”

While everyone expected an economic correction, no one could have envisioned the extent of the impact the virus would have on a global scale.

How does this unprecedented challenge impact PE partnership? Ben Gibbons, National Private Equity Leader – Canada for RSM Canada says there’s significant additional value in partnering with private equity during trying times.

In challenging times, PE firms are adept at navigating a similar playbook [compared to good times], being defensive where required and assisting a company take advantage of difficult markets with access to capital to make opportunistic acquisitions or other investments that will reap benefit over an appropriate time horizon. Important areas that PE firms support companies during challenging times are ensuring liquidity and cashflow are appropriately managed, supporting discussions with financial stakeholders (lenders, suppliers and customers), profit improvement initiatives and access to capital where needed.”

Turnbull shared similar views.

In challenging times, such as this COVID-19 crisis, a rapid response and ongoing management of this crisis is essential. Workforce safety and mobility, ongoing communication with all stakeholders, contingency planning, potential cost-cutting measures, cash flow management and ongoing forecasting, debt restructuring, and renegotiation of key agreements. PE fund managers have a vested interest in the business’ success.”

While it is still early to tell how the private markets will look moving forward, there are initial indications at the early stages of the pipeline, that there will be a noticeable negative impact on funding. CB Insights released a brief on March 20 indicating a 22% decline in seed-stage funding in Q12020 vs Q42019. The CVCA anticipates releasing a preliminary look at Q1 performance in the coming days.

We asked Turnbull and Gibbons how they foresee private equity performance adjusting to new market conditions.

The COVID-19 crisis is creating tremendous uncertainty around the extent of its impact and timeline to recovery,” said Turnbull. In aggregate, short term valuations are falling, exits delayed and depending on the type of fund and LPs, delays in new investments. Deal volumes have dropped sharply. However, I believe this is a temporary slowdown as there is a tremendous amount of liquidity and borrowing rates are low. Once this market stabilizes, Manulife’s Private Company Advisory Group is forecasting a strong return of M&A and Corporate Finance deal activity as some buyers were inactive at the previously high valuations.”

We’re expecting to see the next few months remain lower in deal count as PE continue to work through impacts of the existing portfolio as a focus area,” said Gibbons. However, we do see some significant dry powder in the market and expect H2 of 2020 to show some significant activity. Our expectation is that we will see business owners be inclined to re-evaluate their succession plan, minority equity deals be more of a feature and corporate carve-outs increase as PE firms evaluate where their capital can be put to use in a market that was very different than 2019.”

Managing what is on the horizon will require agility, resolve and creativity as no one can predict how long and how deep the economic impact of COVID-19 will be on the economy. We believe PE backed portfolio companies will be well supported, only time will tell if they will outperform publicly traded counterparts.