For private equity firms, 2022 has been a rough year. Take-private purchases of public companies have come to a virtual halt, as large transactions struggle to find debt financing. Funds are having to take markdowns on their investments. And sponsors are stuck holding companies that they would have rather sold off — to a corporate, another sponsor, or the stock market.
The inability to exit an investment is particularly troublesome. According to PitchBook's 2023 U.S. Private Equity Outlook, the exit-to-investment ratio for PE firms stood at 0.38x at the end of the third quarter, the lowest since the global financial crisis in 2008. The number of exits was down 57%, as of September 30. The macro headwinds are likely to persist into 2023, said PitchBook.
Exits are hampered because not only is the IPO window shut, but "sellers are less motivated than buyers to lock-in lower prices," according to Kyle Waters, a PitchBook associate analyst. No one wants to be a forced seller in an unattractive market climate, according to PitchBook. Said Waters, "It may take an extended period of time for sellers' expectations to change and align with [those of] buyers."
Corporations are also not apt to buy PE-owned assets now, as they await a potential recession, focus on preserving cash, and remain conservative with balance sheets. Compelling valuations, however, could at some point "prompt them to take up sponsor-backed companies from PE sellers," said Jinny Choi, a PitchBook PE analyst. Some companies may also seek to do so to add recession-resilient businesses.
Many of the exits that do happen next year will be sponsor-to-sponsor — so-called "pass the parcel" deals. Sponsor-to-sponsor exits accounted for a 63% share of all exits on a trailing six-month basis as of the end of the third quarter, said Choi, about 10 percentage points higher than they have been the last 10 years.
A record number of these transactions could occur next year, as PE sponsors have plenty of "dry powder" they need to put to work — $788 billion as of the third quarter.
Finally, PE sponsors can't be thrilled about the valuations of the companies they once owned that listed the past two years, especially if they still hold shares.
A two-year frenzy of IPOs and SPAC transactions that ended earlier this year spawned 952 new listings and $2.6 trillion in inception value, according to Tim Clarke, a senior analyst at PitchBook. But 644 of those companies now have market caps below $1 billion, making them middle-market companies. The current aggregate market value of those 644 companies is $164.5 billion, down 76% from when they went public.
Ironically, some of these companies will likely "populate the ranks" of take-private transactions in the future, Clarke said, and "the buyout pendulum will likely swing back in favor of the middle-market segment."