The Price is Right? The Impact of a Challenging Environment on Pricing and Valuations
Last year presented a number of hurdles for managers in the private capital markets, with many thinking 2024 couldn’t come quickly enough.
An uncertain geopolitical backdrop combined with rising interest rates and a tougher exit environment all resulted in a degree of caution that widened the gap between what buyers were willing to pay and sellers were willing to accept.
But as we move into the second month of a new year and with interest rates at least for now appearing stable, there is hope for a stronger year ahead.
Notes on a challenging year
There’s no doubt that the past 12 months have been tough for the alternative investment fund sector as a whole. Recent statistics issued by Preqin highlighted that in 2023 only 874 private equity funds closed, compared to in excess of 1,400 annually in previous years.
Meanwhile aggregate capital raised by real estate funds globally fell by 19% year on year to $107.7bn in Q1–Q3 2023, compared with a 17% drop between 2021 and 2022 (Preqin 2024 Global Report: Real Estate).
In addition, funds have taken longer to raise; in North America, the proportion closing after more than 24 months leapt from 31% in 2022 to 57% in 2023.
And, while fundraising in the private capital space globally more or less matched that of 2022, it was predominately the larger established funds driving these figures - a trend mirrored in the public markets where the bigger players, such as the ‘Magnificent Seven’, were attracting the majority of capital available in the sector.
Unsurprisingly, the resulting depletion in deal flow activity had a knock-on effect for the fund-raising attempts of existing managers with the delays in returning the capital on established investments impacting managers’ ability to set off on their next fund venture.
All in, this has led to an uncertain picture, especially when it comes to valuations.
Consequently, a cavern has opened up between the prices buyers and sellers are prepared to agree upon with many managers choosing to hold on to key assets rather than sell for what they perceive to be an under-valued price.
Interest rates
Where deals could be agreed and pricing aligned, higher levels of interest rates contributed to increased costs of debt, leading managers to scale back on leveraged buyout activity and look for more creative ways to fund and get deals over the line. And, in the fight for liquidity in an illiquid market, managers in the secondary and more opportunistic space were still actively looking to get deals done while facing the same challenges on pricing.
Interest rates - for now at least - look likely to remain stable with a very real prospect of falling as we move through 2024.
As a result, some common ground on pricing will hopefully be reached to kick start much-needed deal flow activity and astute fund managers cognisant of the opportunities will no doubt be looking to pick up investments at favourable pricing, particularly from sellers looking for liquidity.
Year ahead
Despite events of the last year, there is still much to be positive about for 2024. According to S&P Global Market Intelligence and Preqin data, there was an unprecedented $2.59trn of dry powder in the global private equity pot – an 8% rise on the previous year.
This has the potential to be significant; appetite to utilise this capital to leverage deals later in the year buoyed by stable – or falling interest rates – could provide the boost needed to get deals across the line.
But, while some of the larger players still achieved successful fund raising in 2023, for the vast majority, a degree of cost rationalisation and revision of their operating model for the future was necessary.
Consequently, from a professional services perspective, it will continue to be imperative to support managers in navigating that process as well as having the innovative mindset capable of providing the solutions to operational and structural pinch points.
Of course, a decrease in valuations would naturally provide some much-needed momentum and, when combined with greater certainty on interest rates underpinning better alignment between buyers and sellers, should prompt a return to form on deal flows.
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Ashley Vardon is Senior Director - Fund Services at JTC
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