Private equity – COVID-19 preliminary impact

Down down…

The draconian lockdown measures imposed on many parts of the global economy will have material impacts on private equity markets across venture capital, growth equities, leverage buyouts strategies. The degree of impact will vary depending on regions or industries or strategies, but regardless, private companies will generally be adversely impacted by supply and demand-side disruptions; and yes, there will be some sub-sectors/businesses that will benefit from the COVID-19 crisis, such as online consumer platforms and essential healthcare businesses.

Over the past couple of years, many of our private equity managers have been anticipating a possible market downturn scenario, given the late stage of the business cycle, and have defensively positioned their portfolios by investing in defensive sectors (education, technology, healthcare), defensive businesses with sticky revenue and strong free cashflow and with relatively conservative leverage. However, with the partial shutdown of economies, these defensive sectors (less so for technology) have also been impacted. The magnitude of the impact will depend on the duration of the lockdown, which is the key unknown, and the size of stimulus by governments and central banks.

Private equity’s quarterly valuation cycle has normally benefited investors by providing artificially low volatility but, in this instance, it has created a problem for Australian institutional investors, especially superannuation funds which are dealing with member switching and early access to superannuation. Unfortunately, many private equity managers are still compiling and assessing data for portfolio companies for Q1 2020 valuation and it is difficult to provide timely valuation data to investors. The consensus is that there will be some negative impact on Q1 valuation, but it will be Q2 and Q3 that will be most likely impacted by COVID-19.

Cash is King

In this crisis, where liquidity and cash runway are crucial, Cash is King! Private equity managers have been actively positioning their portfolios to weather the storm by;

• Limiting new investments – given current market uncertainties but also to reserve capital for potential equity injections for existing portfolio companies;
• Building cash reserves of portfolio companies – drawing down revolver facilities, cutting non-
• essential costs, restructuring of businesses, etc;
• Reforecasting financials on 3,6,9 months scenarios to assess potential cash runways;
• Initiating early discussions with lenders.

Most portfolio companies have gone into survival mode preserving cash both to survive potentially months with reduced revenues, and to build capital reserves to restore capacity post-crisis and even increase market shares via market consolidation.

Patience is the key

The COVID-19 crisis will impact private equity investments over the short-term, however we believe our managers are well placed to weather the storm through active portfolio management, diversification and defensive positioning of their portfolios.

Private equity is a long-term game and the best private equity vintages often arise in the aftermath of a crisis, much like the GFC. We believe investors who are able to maintain their long-term private equity programs will be rewarded over the long term.