The Opportunity for Private Equity Investment in a Challenging Global Environment

Private equity started this year riding a wave of momentum. In 2021, the global industry enjoyed record deal sizes and the second-best fund-raising year for general partners (GPs) in history, according to Bain & Company’s Global Private Equity Report 2022. In Canada, the PE deal count was more than 20 percent higher than the previous record, set in 2019, and dollars invested returned to pre-pandemic levels, according to the CVCA. ​“Valuations were at historical highs across many sectors, and companies could secure capital and sell their business at great prices – so it was not surprising to see record transaction levels in 2021,” says Justin Catalano, Managing Director and Group Head of Private Equity at Fengate Asset Management in Toronto. 

But what a difference a few months can make. Today, the high inflation that many observers thought would be transitory only a few months ago seems to have settled in. In response, monetary policymakers have rapidly shifted from dovish to hawkish and appear to be accelerating what is anticipated to be a historic tightening, with the Bank of Canada recently raising its benchmark rate by 50 basis points – the largest one-time hike in more than 20 years. Against this backdrop of tightening financial conditions, outsized rate increases on the horizon, conflict in Ukraine, and lockdowns in China have exacerbated pandemic-related global supply chain issues, further stoked inflation, and contributed to additional volatility and uncertainty in capital markets. Catalano’s group, however, was ​“very disciplined in its capital deployment in 2021, given the market environment,” he says. ​“I believe that decision has positioned us well going forward in this dynamic environment.”

Trying to assess how such major geopolitical and economic developments will ultimately impact the PE industry is tough, but one can already see opportunities and challenges emerging, says Catalano. ​“We believe great opportunities to invest will come out of the sheer amount of change occurring – for example, deglobalization should create interesting opportunities in North America,” he adds. ​“However, patience will be critical, because economic turbulence and volatility in capital markets will present challenges that will need to be incorporated into our investment theses.”

With over $400 million available for future growth investments, Fengate Private Equity focuses on providing ​“transformative growth capital” to an underserved part of the market: entrepreneurs who need not just financing, but also a partner who can provide strategic resources and management expertise to help their businesses grow faster and smarter– and help them navigate the choppy waters ahead. ​“We want to cause a lasting positive change in the businesses we invest in,” explains Catalano. ​“We accomplish this by supporting our partners with the financial, human, and strategic resources required to navigate both the opportunities and the challenges entrepreneurs encounter as they scale their business.” 

Since the creation of its investment strategy in 2016, Fengate Private Equity has had some high-profile successes – for instance, it invested $40 million in theScore Media and Gaming in 2019, one of North America’s most popular sports platforms, which was subsequently acquired by U.S.-based Penn National Gaming for US$2 billion in 2021. And Catalano sees continuing potential for his group’s strategy in 2022.

One opportunity, he says, could arise in the wake of last year’s record-breaking IPO market. More than 150 companies went public on TMX Group exchanges last year – the most in history – but in many cases, their stock prices have gone on to decline by double-digit percentages since then. ​“Companies are trading well below their 2021 IPO prices,” says Catalano. ​“Many of these businesses will continue to require capital and maybe challenged attracting capital at their current share prices.” For PE firms, which typically have a five-year-plus investing window, such companies could be attractive over the medium to long term, and Catalano expects more PE participation in PIPE (private investment in public equity) deals this year, at least for those GPs like Fengate whose mandate allows for that type of investment.

Dealing in the new environment will not be all about finding opportunities, of course; it will also require continued navigation of volatility caused by both current events as well as longer-term, more challenging issues such as climate change. In the face of such volatility, he expects more GPs to build downside protections into their deals. ​“We have always believed in protecting our investors through structural protections”, he says. ​“If these last few years have taught us anything, they have reaffirmed our commitment to ensuring we have the appropriate structures necessary to drive strong risk-adjusted returns.” 

Clearly, responding effectively to rapidly shifting economic and financial conditions will be critical for PE. But it will also be important to avoid overreacting to short-term trends, says Catalano. ​“It’s important to continually remind ourselves that we are patient investors,” he adds. ​“Are we investing in great businesses besides great partners? Have we set them up to be successful for both their shareholders and employees as well as within their communities? Are we providing the support necessary to help our partners realize their growth ambitions? Ultimately, those are the questions that we need to answer to be successful.”