Yet, this environment may offer strong opportunities in some areas, especially in the mid-cap space, a segment we believe offer more room for value creation; the latter being fundamental today; or in the secondary market where you can still acquire high-quality assets at attractive discounts said Florent Saint-Quentin, Head of Private Equity Investor Relations (Europe) at Indosuez Wealth Management.
If 2021 and the first half of 2022 offered record-high fundraising and deal activity, the second half of 2022 was marked by a rather significant slowdown. This trend continued in 2023 with a 20% decline in fundraising; mostly affected by the lack of distributions as many Managers hold onto their assets due to lower valuations. This reduced the capacity of Limited Partners (“LPs”) to reinvest into new vintages.
Value creation is key
In 2023, performance across private equity was subdued and below historical average. With reduced leverage capacity and lower multiples, performance will focus more going forward on value creation skills i.e. the capacity to grow a company or an asset through revenue or margin expansion. Managers with hands-on value creation capabilities and experience across different economic cycles would most likely stay ahead of the market. Consequently, we observed in 2023 a greater discrepancy in terms of performance across asset managers. This is one of the reasons why our franchise has remained, over the last decade, focused on selecting experienced General Partners (GPs) with repeatable value-creation skills based on operational improvements added Florent Saint-Quentin. Indosuez works with 100+ trusted Private Markets GPs from all around the world who identify and nurture such value creation opportunities.
To illustrate the importance of this strategy, Mr Saint-Quentin cited a couple of recent co-investment examples. Indosuez invested alongside a GP and took a minority stake in an industry-leading provider of dental surgical services operating in the US. “The value creation strives to strengthen organic growth through new market penetration; provide operational efficiency by centralizing certain services/functions and acquire similar companies given the highly fragmented nature of this industry”.
The value creation strives to strengthen organic growth through new market penetration; provide operational efficiency by centralizing certain services/functions and acquire similar companies given the highly fragmented nature of this industry
Similarly, our franchise co-invested in a company specialized in asset maintenance, upgrade and repair services to power and water infrastructure operators in the UK, he added. The value creation plan is to support the existing client base in their journey to more sustainability, penetrate new markets, build a nationwide coverage through an accelerated M&A strategy and further develop the use of new technology to support the service offering.
High potential in mid-cap investing
Of course, an investment is only good value if the asset itself has growth potential. “We do believe that there is more potential for growth and value creation in the mid-market segment.” As a matter of fact, the investment universe is wider than large cap as it includes millions of businesses valued from EUR 50M to EUR 1Bn with high growth potential. “Navigating such a deep space requires a large and global network and stringent selection skills.”
In addition, mid-market offers more potential for operational value creation by leveraging various “easier to implement” levers such as buy and build strategy, new market penetration, cost reduction, market repositioning, etc. It has also historically shown more resilience through economic cycles due to lower use of leverage and the fact that it transacts at lower valuation multiples. However, “We don’t mind paying more for companies showing e.g. high growth potential, visibility on cash flow generation or resilient customer base,” he noted.
Finally, mid-market companies offer more channels of exits, including sales to the industry or to other GPs; hence rely less on IPOs. As a matter of fact “we’ve been seeing encouraging signs on the M&A side in our mid-market portfolio with deal activity regaining momentum since the beginning of 2024. We have exited several companies globally with marked-up valuations the past 6 months. We anticipate transactions to gradually come back for the end of 2024/beginning of 2025, supporting a recovery in volume of distributions to investors.”
“This mid-cap approach has been central to Indosuez’s strategy for over a decade. It has proven to be resilient during difficult times, while maintaining upside potential and distributions in unfavourable market conditions,” concluded Florent Saint-Quentin.
Secondary market still attractive?
Fundraising skyrocketed over the last two years on the back of increasing interest and a lower lending capacity from banks
“We are pretty positive on the secondary market. In the current environment, we see high quality GP assets and LP interests offered at attractive discounts,” said Mr Saint-Quentin. Due to the denominator effect and the sharp decline in bonds and equity prices in 2022 and 2023, institutional investors were required to sell private equity positions (LP-led), even though at a discount, to maintain asset allocation ratios. As exits have paused, some LPs continue to go on the secondary market to trigger liquidity to be later reinvested in new vintages to maintain accesses to top managers.
On the same vein and as distributions remain challenged, various GPs are willing to go on the secondary market to generate liquidity through the proceeds of assets. “At Indosuez, we’ve built over the years proven pricing & execution capabilities coupled with an extensive network favouring strong asset knowledge and access to the best secondary transactions” mentioned Florent Saint-Quentin 2024, a new set of opportunities in Private Debt & Real Estate?
As for the private debt market, Mr Saint-Quentin is cautious. “Fundraising skyrocketed over the last two years on the back of increasing interest and a lower lending capacity from banks,” he noted. However, he highlighted to remain selective and cautious as default rates could increase significantly in the next two years due to increased pressure to meet interest coverage ratios. He concluded that falling interest rates might change this overall dynamic.
For real estate, prices are 10%-20% down from their peak and volumes are down 40% in certain segments but he sees signs of the market having bottomed out opening compelling opportunities for contrarian opportunistic buyers. “This could be a good entry point,” said Florent Saint-Quentin. Particular vigilance is required in the commercial sector, but residential, data centres, and prime green offices in areas with low vacancy rates may show more overall promise.