What Books to Read to Succeed in Private Equity

At a Glance

• Private equity took a big second-quarter hit from Covid-19 but recovered with impressive speed as the year wore on.
• Deal value, exits, fund-raising and returns all concluded upwards relatively stiff.
• A drop-off in bargain numbers left pent-upward demand for investments in 2021, simply navigating a post-Covid world will require strong due diligence and deep sector expertise.

This article is office of Bain's 2021 Global Private Disinterestedness Written report.

Information technology was a year of massive disruption—and individual equity emerged unscathed.

Despite the tragic Covid-19 pandemic and its global economic fallout, despite the protests confronting police brutality and systemic racism and months of social upheaval, despite a bitterly contested US presidential ballot that ultimately led to an unprecedented mob assault on Capitol Hill, dealmakers kept making deals in 2020, while exits and fund-raising fell in line with robust five-year averages (see Effigy 1).

Similar much else across the global economy, private equity activity fell off a cliff in April and May as buyers and sellers akin absorbed the initial stupor of authorities stay-at-home orders. Simply even as full deal count remained subdued throughout the year in most sectors, deal and exit value snapped dorsum vigorously in the 3rd quarter. In terms of putting large chunks of money to work, the year'southward 2d half ended upwards existence every bit potent as any two-quarter run in recent retentiveness (meet Figure 2).

What'south too evident is that the overall 24% drop in bargain count during the year left enough of unfinished business. Based on heavy global action in early 2021, pent-up demand will likely have a stiff positive impact on electric current-twelvemonth deal numbers. All indicators propose that funds will go on to chase deals in the sectors least affected (or actually enhanced) past the ongoing Covid-19 crisis.

In some respects, the manufacture'south quick rebound isn't surprising: One of private equity's indelible strengths is its ability to thrive during periods of economic disruption. Downturns typically offer PE funds a relatively leisurely opportunity to detect distressed assets and ride the bike back up. This shows in the returns of fund vintages from the trough years post-obit the last 2 economic downturns―2002 and 2009. They averaged internal rates of return (IRR) in the 17%–21% range, a salubrious premium to the 16% long-term PE average.

Merely this crisis was different. While a short-lived opportunity for distressed investors produced deals like the multimillion-dollar recapitalizations of Wayfair and Outfront Media, the value window slammed close quickly. Both global credit and public equity markets rebounded with blinding speed over the summertime, pulling private asset prices (which are highly correlated with public equites) along with them. Consider that information technology took nearly seven years for the S&P 500 to get dorsum to its precrisis high after the global fiscal crunch of 2008–09. This time effectually, the S&P reclaimed its losses within 150 days and finished the yr 16% higher than where it started (run across Figure three).

This steep V pattern owes to several factors. First, coming into the Covid-19 crisis, private disinterestedness funds were bursting with dry out pulverization. Full general partners were as eager equally they've e'er been to put coin to work, and the explosive growth of special-purpose acquisition companies (SPACs) in 2020 added more than $40 billion to the pile of capital letter chasing buyout deals (run across "SPACs: Borer an Evolving Opportunity").

Few were willing to make buy/sell decisions during the period of disorientation immediately following Covid-xix's global spread. But the mood flipped when central banks in the The states and Europe aggressively pumped trillions into the financial economic system, easing liquidity concerns for firms and their portfolio companies (see Figures 4 and 5). That shifted attention from portfolio triage back to making deals.

The rapid stimulus boosted confidence that the malaise in the real economy would be temporary. It also fabricated the flood of cheap debt available to fund transactions even cheaper. Rising asset prices and fears of a capital gains tax hike in the US, meanwhile, encouraged sellers to put avails on the market―especially PE sellers transacting sponsor-to-sponsor deals. The net effect was a second-one-half surge in large deals that more made up for the second-quarter drop in value.

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The challenge moving into 2021, of class, is that the crunch is nevertheless very much with usa and its economical impact remains extremely hard to forecast. Although vaccines are on the mode, Bain'southward Macro Trends Grouping projects that challenges to global economies are probable to persist through 2022, and the global regulatory response to this menses of crunch could be meaning.

This has several of import implications for investors in 2021 and beyond:

• The game might not be over for value investors. The great unknown in the wake of the Covid crisis is how long fiscal and monetary policy can hide any underlying structural damage to economies around the world. Somewhen the stimulus will launder away, which could remove vital support from sectors that have relied on it. By downturns tell us that a Five-shaped recovery tin can apace turn into a W. That could bring downwardly valuations in sure sectors and create the kinds of distressed opportunities that evaporated so quickly in 2020.
• Today's valuations leave little room for mistake. Soaring nugget prices in sectors similar applied science hateful that multiples for deals getting washed today are at or near record highs. The simple math says that GPs buying companies at these prices will have to generate more value if they are to brand skilful on return expectations―and they will take to do then in a highly volatile and uncertain business environment. A Bain assay of hundreds of funds in which we coinvest shows that multiple expansion and acquirement growth (not margin improvement) are by far the biggest drivers of PE returns. Funds will have to notice ways to improve that mix if they aim to replicate the returns they've posted over the past decade.
• Deep sector and subsector expertise has never been more important. The better y'all know the sectors y'all are investing in, the ameliorate you'll empathize how they are going to alter and how you tin take reward of information technology. Firms need in-depth intelligence on how the recovery will unfold in a given sector and where the basis has shifted. Many industries accept inverse fundamentally in the wake of Covid-19 in ways that can alter profit pools. Customer expectations may have evolved; disruptive innovations may have been pulled forrard. The firms that can spot change first and build those insights into the PE value chain will have a singled-out advantage in the post-Covid hereafter.
• PE firms need to accelerate their plodding transition from analog to digital. Private equity remains a highly labor-intensive, newspaper-driven industry. The pandemic held up in loftier relief how inefficient this is. Non every coming together with investors or portfolio company management has to involve a flight, a hotel room and two days' turnaround time. Interactions tin be faster, more than frequent and every bit effective on Zoom. PE firms accept get expert in diagnosing the need for digital change at their portfolio companies. Becoming more competitive in the years ahead will mean bringing those lessons home.

A major element of going digital will be excellence in using tools and analytics throughout the individual equity value concatenation. Earlier Covid-19 hitting, the almost effective firms were already deploying artificial intelligence, big data, web-based analytics and other technologies to make smarter, faster decisions about companies and their prospects. Over the past twelvemonth, they've learned that these tools can lead to significantly deeper insights into how manufacture patterns are shifting, where disruption is coming from and whether their portfolios are prepared for whatsoever is coming next. Digitally aided due diligence is rapidly condign table stakes.

It's safe to say that nobody saw what was coming in 2020. All the same the industry managed to discover a way forward. Here'due south how the yr unfolded in terms of investments, exits, fund-raising and returns.

Bain'south Hugh MacArthur reflects on the resiliency of private disinterestedness over the by yr and forecasts a busy 2021.

Investments

Having rebounded impressively from a dismal second-quarter performance (North American deal value solitary was off 85% from the same quarter a twelvemonth earlier), the global industry sprinted to the cease in 2020, generating $592 billion in buyout deal value. That was an 8% jump from 2019'due south functioning and seven% higher than the five-year boilerplate of $555 billion (see Figure half dozen). A total $410 billion of that total came in the third and fourth quarters every bit GPs raced to put money to work. Confidence reigned that fundamental bank stimulus would prop up the global economic system long enough for the worst of the Covid-19 pandemic to pass.

Covid did have a pronounced negative affect on global deal count, every bit the number of buyouts cruel 24% to around iii,100 in 2020, from 4,100 in 2019. With the exception of the engineering science and telecom sectors, the number of deals slumped across the business landscape compared with the five-year boilerplate. The retail, consumer, and media and entertainment sectors were among those taking the biggest hits.

This drib in bargain numbers was dramatic, but information technology is probable to exist temporary. Due diligence activity around the world was as stiff as it'due south always been in early 2021, suggesting that many of the deals postponed amid the pandemic anarchy will eventually go done. That should provide a structural scaffold under 2021 activity.

The reason full deal value rose in 2020 while volume slipped was a 24% increase in average bargain size to $776 million. That reflects the ongoing concentration of the PE industry―bigger funds have to do bigger deals to motion the needle for investors. Banks also made more than financing available for large deals than for smaller ones. In a jittery marketplace, they were almost comfortable lending to well-established GPs acquiring big, stable targets.

How deal activity unfolded regionally in 2020 was largely a part of where Covid-19 struck and when. The Asia-Pacific region saw the biggest affect in the first quarter equally China wrestled with containing the initial outbreak of the virus. North America got slammed in the second quarter only managed to recover by June. Europe was slower to rebound as action lagged in both the second and third quarters. Information technology roared dorsum in the fourth quarter, withal, and European firms finished the twelvemonth relatively strong (see Figure 7). Amid the ups and downs, individual equity managed to increment its share of total merger and acquisition value, capturing xvi% globally.

Sky-high asset prices are by far the biggest challenge facing PE investors. According to a Dec 2020 Preqin survey, investors see asset valuation as the most significant challenge in trying to generate strong returns. Among heavy competition and a alluvion of investment capital letter―both debt and equity―buyout multiples continued to defy gravity in 2020, averaging 11.4 times earnings before interest, taxes, depreciation and amortization (EBITDA) in the Usa as of yr-terminate and a tape 12.6 times in Europe (run across Figure 8). As a measure of how hot the market was, around 70% of United states buyouts priced above eleven times EBITDA (see Effigy 9).

Multiples rose across industries in 2020 but were particularly buoyant in the sectors most immune to Covid-nineteen (such as payments) or those that benefited from the pandemic (like technology). What amounted to a flight to quality meant private disinterestedness targeted companies that could support more than debt, and banks were happy to supply it. Despite the deep doubt surrounding the Covid-19 economy, debt multiples shot up in 2020, with almost 80% of deals leveraged at more than 6 times EBITDA—traditionally the level at which federal regulators start to raise eyebrows (encounter Figure 10).

These dynamics have been at play for several years, every bit express partners continue to pile coin into the manufacture faster than GPs can put it to work. Unspent private upper-case letter overall, including that committed to venture, growth and infrastructure funds, has grown in stair-step style since 2013 to almost $3 trillion, with effectually a third of it attributed to buyout funds and SPACs (see Effigy xi).

Buyout dry pulverization is also at record levels, which is certainly a factor in rising toll multiples. But there is little evidence to suggest that buyout funds are under undue force per unit area to put money to work. While the buildup of unused capital in the overall alternatives market place can induce vertigo, the growth in buyout funds has been much more than subdued (see Figure 12). The average age of buyout capital remains under control, and the amount in reserve equates to effectually two years' worth of investment, far less than in the years following the global financial crunch (run across Figure 13). Dry powder is an issue but not a crusade for warning.

Amid the chaos that defined 2020, PE funds showed remarkable resilience. Given the length of the economic expansion leading into the twelvemonth, most firms had been carefully preparing for an impending recession by focusing on the economy'south most durable seams. Entering the pandemic, however, was like stepping through the looking glass. Traditionally recession-resistant sectors similar retail wellness clinics suddenly turned toxic every bit stay-at-dwelling house orders halted movement overnight. Meanwhile, many of the cyclical sectors that tend to tank in a downturn―home improvement, recreational vehicles, gardening retail―took off like a shot.

The ability to pivot quickly became the primal to survival for many portfolio companies. In February 2018, RVshare, a fast-growing peer-to-peer RV rental market place, took on a $50 1000000 investment from Tritium Partners to fund growth. Merely two years afterward, the pandemic hit with full force and business tanked amid a wave of rental cancellations, which drained cash from the residual canvas. That forced the executive team to scramble for ways to both retain existing customers and find other sources of revenue.

The company cut a deal with Ikea's TaskRabbit to disinfect every rental before and after the contract menstruation. It began renting vehicles to doctors and utility companies for emergency use. And so, as the summertime wore on and camping became a last refuge for the millions forced to cancel more exotic vacations, the company'southward fortunes shifted again. Business accelerated and bookings soared. In October, the company raised another $100 million investment led past KKR.

Artistic triage was common. Bain Capital'due south Apex Tool Group used 3-D printing to make hundreds of face shields for healthcare workers. L Catterton'southward ClassPass market launched a new service that enables fitness and wellness providers to live-stream classes and manage appointments through the ClassPass app and website. Edison Partners' Suuchi pivoted from its cadre business of providing supply chain optimization software for the lingerie and infant wear sectors to edifice a new acquirement stream in personal protective equipment.

Entering the pandemic was similar stepping through the looking glass. The power to pivot apace became the key to survival for many portfolio companies.

Some of the changes companies are making in response to Covid-19 will outlive the pandemic; others will non. Deciphering the new normal and reacting accordingly will exist a major claiming for portfolio companies in the months and years alee. One thing the pandemic has highlighted is that broad sector definitions aren't that useful anymore. Developing proprietary investment theses and generating strong deal pipelines increasingly volition depend on specialized industry knowledge and nurturing proprietary networks of experts and advisers.

Consider healthcare. Information technology is well known that telemedicine and nonhospital care models took off during the pandemic, and PE investment followed. Deals involving outpatient and dwelling house care companies more than tripled to $3.9 billion in 2020.

Simply other, less obvious areas also popped. Life sciences companies that make tests and tools saw huge increases in business organisation as governments and providers scrambled to offer more Covid-19 testing. The same was true for whatever company that sells tools for vaccine researchers or technology that enables scientists and pharmaceutical companies to collaborate. Indeed, one longer-term result of the pandemic has been to expose ways in which clinical trials can be improved to rely less on concrete interactions. That is opening opportunities for businesses that provide services like remote patient diagnostics and monitoring.

At the aforementioned time, healthcare sectors that ordinarily concur upward well in a downturn faced increased pressure in 2020 considering of delays in elective procedures. Hospitals, convalescent surgery centers and retail health clinics all suffered, though the impact varied by sector and company. For these businesses, the question is, how long will the Covid effect last, and what volition the long-term effects exist?

Overall, the number of deals in healthcare held upward quite well in 2020. Simply placing the correct bets required existent-fourth dimension understanding of Covid-nineteen's impact, subsector by subsector, and knowing which of those impacts might alter a visitor's trajectory in the hereafter, with both upsides and downsides to consider.

The broad technology sector attracted the well-nigh PE investment in 2020 (29% of total buyout deal count globally, 32% including fintech), with several subsectors continuing out (see Figures 14 and 15). Funds gravitated toward SaaS-based businesses with particularly gluey business models, like vertical software. Gaming got a large boost from a single deal, a $ane.5 billion funding round for Ballsy Games led by KKR, Baillie Gifford and BlackRock.

The financial sector also drew significant private equity involvement despite the slumping economy, which typically hits the sector hard. But here again, subsector dynamics mattered. Insurance didn't run across much activeness, while the payments sector was on fire (as we predicted last year). The secular shift to digital payments that was already well underway got a Covid-19 boost when retailers and consumers akin backed abroad from greenbacks in favor of cards and other forms of online payment. Deals involving payments companies fabricated up 24% of full financial services/fintech investment value in 2020, up from sixteen% the year before.

Given that nosotros are still battling the Covid pandemic, the expected stiff deal activity in 2021 will probable follow these same patterns. We would expect to see subsectors immune to Covid-xix—or given new momentum by the pandemic—keep to concenter interest, while hard-hitting areas like hospitality, retail and energy may provide rolling opportunities for distressed investing. Amidst the continued disruption, individual equity firms may demand to fundamentally shift their sector accent to succeed in this disjointed marketplace. As nosotros've noted, deep subsector expertise has never been more than of import.

Exits

Exit action in 2020 followed the same pattern as investments. Both buyers and sellers hunkered down when the Covid-xix pandemic hit in the spring, and second-quarter activity went into a sideslip. But exit value picked up in the second one-half, as revived price multiples and the threat of a taxation-constabulary change in the Usa gave sellers ample incentive to put companies on the market―peculiarly big ones. The number of exits trailed 2019's total, merely owing to an increase in deal size, global get out value hit $427 billion in 2020, on par with 2019 and in line with the five-year average (see Effigy sixteen).

Once over again, strategic buyers provided the largest go out aqueduct. Sponsor-to-sponsor deals held up well, and initial public offerings increased past 121% to $81 billion as public equity markets soared. Firms as well leaned heavily on partial exits, as GPs sought to go on a stake in attractive assets rather than take to hunt downwards new prospects in a highly competitive deal market place. Overall, the median property period for companies exited in 2020 was 4.5 years, slightly higher than in 2019 simply in line with the five-twelvemonth average (see Figure 17).

Fund-raising

It's hardly surprising that many GPs were afraid Covid-19 would put an end to the past decade'southward gilt era of private equity fund-raising. Only those fears turned out to be unwarranted. Global fund-raising of $989 billion was a decline from 2019's all-fourth dimension tape of $1.09 trillion (see Figure 18). But information technology was still the 3rd-highest total in history, and if you add in the $83 billion raised for SPACs, information technology was the second highest. All told, the manufacture has raised nigh $5 trillion in capital over the past v years. Buyout funds alone raised nigh $300 billion in 2020, or $340 billion if you include SPAC capital aimed at buyout-blazon targets, estimated at $41 billion (see Figure xix).

Information technology's clear that LPs go on to view individual equity every bit a haven in the tempest. Institutions did take a pause in April during the beginning tiptop of the Covid-xix crisis only chop-chop got dorsum to business during the summer. According to Private Equity International's Dec 2020 LP Perspectives Study, effectually 80% of LPs are confident individual equity volition proceed to perform in 2021, and shut to twoscore% say they are underallocated to the asset course. The vast majority plan to either increase or maintain their commitments in 2021 (see Figure twenty).

As enthusiastic every bit LPs are, however, they are becoming increasingly picky virtually the funds in which they invest. A flying to quality in 2020 benefited large, well-established funds most (see Figure 21). Fewer funds closed overall, but those that did skewed big. On average, funds seeking $five billion or more in assets airtight within six months and eighteen% above their initial target. CVC, for instance, raised $24 billion for its Capital Partners Fund 8 in 5 months and beat its initial target by 22%. By contrast, smaller funds with experience took an average of 14 months to close (meet Figure 22).

The exceptions to this blueprint were funds with a crystal-clear focus. Usa-based Symphony Technology, for case, closed its $ii billion Group IV fund in but under 6 months and was 33% higher up target. Montefiore Investment raised €850 million in three months with a focus on France. Even a first-fourth dimension fund like South Korea'southward BNW Investment was able to raise $160 million (32% more than than information technology intended) within five months for a fund focused on high-growth, technology-enabled industrial companies.

LPs too showed involvement in long-concur funds. Cove Hill raised $ane.five billion in long-hold capital, despite having however to exit any of the investments made with its initial $one billion long-agree fund raised in 2017.

Returns

By all indications, private equity weathered 2020's perfect storm without taking a hit to returns. Looking at 10-year annualized IRR, funds take and then far avoided the kind of damage suffered in the global fiscal crunch (see Figure 23).

It helped to some extent that GPs were already preparing for an stop to the tape-breaking, decade-long recovery bike that followed the global financial crisis. But the biggest difference between then and now was the massive government stimulus that buttressed the economy against the worst Covid-19 could dish out. While many sectors saw real harm, many others went untouched thanks to the central banks, and that helped investors maintain or even improve performance across the board.

With the exception of the first quarter, when spooked investors ran for the hills, publicly traded PE firms fared well (see Figure 24). More broadly, while GPs exited fewer deals in 2020, those that did produce exits generated multiples on invested uppercase of most ii.three times, slightly above the five-year average (encounter Figure 25).

The global industry continues to outperform other asset classes over most time periods. The exception has been The states-based fund functioning, which has converged with public averages over the past decade (see Figure 26). This owes largely to the public market'due south remarkable surge in value since the global financial crisis—an bibelot compared with the long-term boilerplate. History suggests that public equity functioning will eventually revert to the mean.

What'due south becoming increasingly clear is how variable PE performance has been across sectors and subsectors. While engineering and business services have soared in the current cycle, the consumer, healthcare, industrials and natural resources sectors (including energy) have fallen off (see Figure 27). At that place has also been broad variance in performance amidst deals focused on subsectors of broader industry groups (see Effigy 28).

This isn't to say that simply playing in the right sector is the hugger-mugger to potent returns. Sector dynamics are non to be discounted, just the pick of company within a stiff sector is notwithstanding more likely to decide deal success. The gap between top-quartile performance and bottom-quartile performance in applied science, for instance, has been broad over the past decade. In the otherwise lackluster energy and natural resources sector, top-quartile returns outpaced those of sectors with higher median functioning (see Figure 29).

The message is clear: Winning investments be in every industry. Finding them and creating existent value requires both deep cognition of sector dynamics and a articulate thesis describing how a given company tin accept reward of them.

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Source: https://www.bain.com/insights/the-private-equity-market-in-2020/

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