Investment Perspectives MARCH 2021 GLOBAL TRENDS IN MID-MARKET PRIVATE EQUITY INVESTING GLOBAL TRENDS IN MID-MARKET PRIVATE EQUITY INVESTING | 1 We are delighted to share our aspects in the management of There are macro developments that perspective and insights on some of portfolio companies: workers’ give us reason to be optimistic. In the major industry trends influencing safety, cost control, and supply chain December 2020, within days of the our private equity business, and what maintenance. In particular, managers, transition period deadline, a new this means for 2021 and beyond. with the support of a banking Brexit deal was agreed between the system that showed more flexibility EU and the UK, removing significant As we reflect on 2020, it is clear that compared to the last recession along uncertainty and volatility from the this was a year of two halves. Private with a greater role of private credit market. As the global vaccine rollout equity deal-making fell sharply as capital as a buffer, particularly in the gathers pace and life returns to the pandemic took hold. Sponsors middle market, ensured portfolio some form of normality, increased quickly turned their attention to their companies implemented important consumer spending will have a portfolios rather than commit to new measures aimed at safeguarding direct benefit on consumer-facing investment opportunities. Indeed, liquidity. In addition, managers businesses, albeit gradually, which there were winners, such as tech and have taken full advantage of simulates the performance of healthcare companies that benefitted programs made available by national companies coming out of a recession. from healthy capital markets and the governments, including tax breaks, History shows that this is an excellent IPO window, and losers, such as travel social security safety-nets and other time to invest. and leisure companies hurt by the economic support tools. lock-down restrictions. However, on A low interest rate environment balance, most portfolio companies The asset class as a whole, particularly coupled with sizeable levels of adapted well to the new conditions the buyout segment, has been able available capital paves the way for and mid-market firms actually fared to influence management decisions, continued high prices for attractive better than many larger companies. intervene with capital to support corporate assets, particularly for As a result, new deal activity picked portfolio companies’ liquidity crises businesses that have shown that up sharply in the second half of the and seize possible acquisition they can adapt to the impact of year. opportunities. Additionally, with the restrictions brought on by the managers taking a more hands-on pandemic. Historically low rates will The private equity industry saw the approach and appointing operating also mean that companies should be development of various trends over partners to look after the assets able to deleverage more quickly and the past 12 months that are expected day to day, private equity has therefore generate equity value. to accelerate in the coming years, developed a model providing for largely due to the repercussions closer collaboration with portfolio of the pandemic. These include companies’ management, allowing for increasing digitization and the so- a rapid intervention on organizational called “flight-to-quality” by investors. and operational changes, often The experience gained during the necessary in emergency situations. global financial crisis (GFC) and its aftermath has helped the industry react swiftly to the pandemic by paying immediate attention to key 2 | GLOBAL TRENDS IN MID-MARKET PRIVATE EQUITY INVESTING | 3 PRIMARIES MARKET OVERVIEW Investors have shown a willingness to continue COVID-19 cases, Capital Dynamics saw a drop in to investors and operating metrics in order to equity deals – the highest on record according to invest capital in private equity during the the number of deals as early as February, while facilitate investment decisions. More tech and to Preqin data. Managers have focused even most volatile time in the market with global in Europe and the U.S. a contraction of about growth-oriented managers have been investing more closely on companies that are industry fundraising reaching over USD 500 billion in 35% occurred from March and April onwards. in digital and artificial intelligence tools to leaders, particularly in countercyclical sectors, 2020. In this context, we have observed a However, Asia, led by China, saw the fastest effectively screen the investible universe and such as healthcare, technology and food & growing bifurcation between top-tier access- recovery in activity levels, ending the first half of refine their pipelines in real time. Furthermore, beverages. restricted managers who are able to meet their the year with a higher number of deals than the we have observed an increasing focus on fundraising targets despite the pandemic, and previous year. In Europe and the U.S., activity managers supporting their portfolio companies The expectation for the next few years is for the rest who are experiencing longer fundraising started to bounce back substantially from June in their digital transformation process. An an increase in sector-focused funds: in 2008, periods. and increased over the course of the year. increasing number of managers have engaged the amount of capital raised by technology- with digital operations specialists to support focused managers represented only 3% of Many investors that were historically willing to companies on a number of different projects, total fundraising globally, while in 2019 this commit capital only after conducting in-person INCREASING SHIFT TOWARDS DIGITIZATION ranging from IT and business integration proportion grew to more than 20%. Despite meetings, now feel more confident in finalizing tasks to digital marketing, data analytics and the ramifications of the pandemic, this “flight- diligence processes remotely, particularly with As highlighted in the introduction, a major e-commerce development. to-quality”, together with high valuations in the respect to re-ups. Similarly, across the primaries trend we have witnessed over much of the past public markets, kept entry prices at high levels strategy at Capital Dynamics, the team has not year is the industry’s increasing shift towards in the first half of 2020, with overall buyout made any fund investments since the onset of digitization, both at a manager and portfolio GREATER SECTOR SPECIALIZATION entry valuations in Europe reaching 11.7x. This the pandemic without having already previously company level, particularly since the onset of compares with 9.3x for the mid-market, which met the managers face-to-face pre-pandemic. the pandemic. Many private equity managers Another major trend that has become more suggests greater value in that segment of the Capital Dynamics believes in the importance have been able to adapt quickly to a new pronounced since the pandemic is greater market. of its primaries team’s ongoing engagement working environment. Virtual annual meetings sector specialization. In 2006, for instance, the with managers in between their fundraising and due diligence video calls with investors percentage of European buyout deals in the processes. and portfolio companies’ management teams technology sector was just 9%. This increased became routine fairly swiftly. to 24% in 2019. This trend has been accelerating Throughout 2020, deal making decreased during the pandemic, supported by the so-called following the spread of the pandemic. Starting Managers are progressively adopting new “flight-to-quality” by investors, with technology with Asia, the geographic area with the first technology platforms to deliver more insights sector deals accounting for 27% of all private GLOBAL TRENDS IN MID-MARKET PRIVATE EQUITY INVESTING 4 | GLOBAL TRENDS IN MID-MARKET PRIVATE EQUITY INVESTING | 5 SECONDARIES MARKET OVERVIEW The secondary market has seen rapid growth in Contrarily, fundraising in 2020 hit record to manage their private equity portfolios, for Below are some examples we are particularly recent years. Transaction volume has more than highs as investors expecting a perfect buying both allocation and administrative purposes. excited about: tripled over the last decade, while the public opportunity poured capital into multi-billion Furthermore, there is also a pent up supply of markets experienced the longest bull market dollar secondary funds such that there was GP-led deals as an increasing number of funds (i) Transactions facing limited to no run in history. Even though these volumes likely twice as much capital raised than are ageing and exits opportunities remain competition. For example, we see GP- have been driven mostly by large transactions, deployed last year. Looking ahead, we believe challenging. led deals with Asian managers as being there have been a number of trends that have that this large amount of available capital will attractive as they tend to be complex and hence require significant structuring significantly contributed to this growth. This drive a highly competitive secondaries market We also expect to find opportunities where expertise while the assets often have a lot includes: on larger deals and on large GP-led transactions. there are liquidity issues, given that the pain of growth potential; (i) An increase in active portfolio It is possible that this effect will be even more from the pandemic will be ongoing for a while. Firms with