P.E. Deal and Exit Volume Drops in Q3 | Chief Investment Officer

After a record setting 2021, private equity deal activity slowed in Q3 2022 as the Federal Reserve continues raising interest rates, according to a report from PitchBook.

The number of M&A, growth equity, and recap deals collectively slowed by 20.4% in Q3 year-over-year.

The slowdown in deals stems from the steepest rise in interest rates since 1977. “Floating rates for loans on leveraged buyouts averaged 4.8% in February before doubling to 9.8% in September. For the old 70/30 LBO template of 70% debt, 30% equity, that means taking the equity component to 50% or more to keep interest costs in check, and we are seeing early evidence of that playing out,” Pitchbook’s analysts write.

The report highlights that health care-based P.E. deal activity has showed resiliency thus far in 2022, because “the sector is broadly seen as acyclical, as insurance and the nondiscretionary nature of health care somewhat insulate providers from changes in consumer spending,” the Pitchbook writes.

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In contrast to the relative strength in the health care sector, the technology sector has slumped in both private and public markets. As of the end of third quarter in 2022, there have been 587 software P.E. deals totaling $129.3 billion. Year-to-date technology deal count is down 24.4% through the first three quarters of 2022.

In Q3, 254 tech deals closed, at an aggregate value of $57.5 billion. Total tech deal value has accounted for 29.2% of all deal volume in 2022. The report concludes that the deal volume in tech “demonstrates that technology is more resilient than other sectors amid the current market volatility.” The slump in evaluations provide a buying opportunity for firms looking to acquire assets at a discount to their previous 2021 highs.

Take-private deals are on track for their second consecutive year of total deal value eclipsing $100 billion. The rise in rates should cause a decrease in the number of take-private deals, which is what occurred in 2007 into 2008 when the federal funds rate rose from 1% to 5%.

Financing these take-private deals is not as cheap as it once was and financing these deals have become costly and risk prevalent. In a deal closed in August, Citrix Systems was acquired in a deal led by Vista Equity Partners. To finance the deal, the newly emerging combination of TIBCO software and Citrix launched offerings in the high-yield and leverage loan markets for a combined $8.5 billion. Ultimately, the offerings were heavily discounted to yield 10%. On the transaction Wall Street reportedly lost $700 million. In the same quarter as the Citrix note losses, quarterly institutional issuance in the leverage loan market fell to its lowest level since late 2009.

In Q3, the number of add-ons as a share of buyout deals reached a new high of 77.9%. PE firms employ add-on strategies to scale their existing platform investments or to create synergies that can reduce costs or add revenue.

Carveout and divestiture deals over the first three quarters of 2022 has nearly equaled its total deal value in 2020. As of September 30, 2022, there had been 302 divestitures or carveouts totaling $73.6 billion of deal value. The report writes, “we can expect more activity in the coming quarters as companies continue to struggle in the inflationary environment and potential recession.”

In 2021, P.E. exits surged by double, as IPO markets were robust with higher multiple evaluations and the boom of publicly listed SPACs that injected capital and new buying entities into the marketplace.

Dropping for the third consecutive quarter, P.E. exits totaled 337 deals in Q3 2022. The full-year slowdown in exits comes after a record-setting 2021, which saw total deal value double any previously recorded years total, at $863.2 billion across 1,781 deals. Year-to-date the median size of a P.E. exit is $360 million. During Q3, P.E. firms exited 121 companies to other sponsors for a total of $34.4 billion of deal value, the lowest sum since the breakout of the pandemic in Q2 2020.

Many P.E. investors anticipate that the end of year and 2023 holds in store a multitude of markdowns in the portfolio of P.E. funds. P.E. firms will be forced to reevaluate the value of their investments given the lower evaluations in the public markets, lowered growth expectations, and higher costs of capital. According to the report, “middle market could fare better as it is less dependent on public market comparables, although continued market volatility will challenge GPs of all sizes and disrupt the incredible run of returns that P.E. has been able to deliver for the past several years.”