As European private equity (PE) funds adapt their strategies to the current climate of rising interest rates and a bear market, deals continue to pass the line despite a more cautious approach from investors and a longer-term exit vision.
In the first half of the year (H1), 4,053 deals were closed, representing a total deal value of €463.5 billion ($469.4 billion) and a year-over-year increase of close to 35%, according to data from PitchBook’s second quarter report.
This was primarily driven by a surge in deal sizes and not deal count, with deals greater than €2.5 billion growing 3x compared to the same period last year.
The European tech sector, which experienced an especially notable boom in 2020 and 2021, continues to play an important role in the continent’s PE landscape but is nonetheless subject to the same private equity slowdown.
On the buy side, the slowdown can be attributed to investors acting with a level of restraint and caution not seen in previous years. As has been observed in the world of venture capital, PE firms are looking to reduce their exposure to riskier investments.
On the sell side, PE companies are inevitably less willing to let their assets go at a time of rising interest rates, plummeting valuations and deflated stock markets. A reluctance to exit prematurely, either through an initial public offering (IPO) or private sale, has driven a decline in the value of the PE funds most exposed to high-growth technology companies, particularly those whose revenue model is based on consumer spending.
As the PitchBook report noted, “In the coming quarters, companies that had invested most heavily in the high-growth technology sector may face the largest valuation and performance headwinds.”
Across the board, “profitable companies at lower multiples have seen less downward pressure on their valuations than high-growth companies where profits are many years off.” The report cited -3% and -5% gross PE returns at Blackstone and KKR respectively as being indicative of this trend, with both firms having previously invested heavily in fast-growing sectors.
Ultimately, devaluations in high-growth, yet-to-profit companies may prove to be a necessary corrective in industries where a multi-year lag between growth and profit has become the norm. Some of the worst hit so far in 2022 include the buy now, pay later (BNPL) space and the hypercompetitive European q-commerce sector.
Devaluations of technology companies are likely to postpone IPOs in the spaces most affected. Already, PitchBook reported that as a share of all PE exits, IPOs in the first two quarters of the year are at their lowest point since Q1 2020.
With IPOs on the back burner, the report observed that “one of the clearer exit routes today is to be acquired by another sponsor, typically by larger funds who can absorb higher valuations and create further value.”
The trend for sponsor-to-sponsor exits can easily be observed in the realm of FinTech, where many companies have had to curtail their IPO ambitions in light of the present macroeconomic environment.
For example, in the second largest European sponsor-to-sponsor exit of the first half, PE group FTV Capital sold the U.K.-based wealth management platform True Potential for €2.1 billion to the much larger fund manager Cinven.
The acquisition came less than a year after several media outlets reported that True Potential was eying a special purchase acquisition company (SPAC) float on a U.S. stock exchange.
True Potential is an example of the kind of FinTech that PE funds have been aggressively acquiring in recent years. Wealth management platforms typically have strong structural growth characteristics, while the technology itself can be leveraged to add value to funds.
Ultimately, investors of all varieties can look at the way PE funds are reassessing their portfolio requirements and exit strategies to reflect the current economic reality and a potential European recession.
A month into the second half of the year, a reduced appetite for risk, a greater emphasis on profit and a longer-term vision for public listings are increasingly being observed across the investment and wealth management landscape.
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