No more smooth sailing for private equity

Jussi Lehtinen


    No more smooth sailing for private equity

    The Finnish Venture Capital Association held its annual seminar last week. As always, the event provided a great occasion to meet old friends and celebrate successes (congratulations!) However, this year it was clear that the smooth sailing of floor-level interest ratings and growing fundraising are giving way to greater uncertainty. From the chatter on the floor at least a few themes were evident.

    Where have all the listings gone?

    “It is a truth universally acknowledged, that a founder in possession of a growing company, must be in want of an IPO”, as Jane Austen put it – or would have put it, had her father been a stockbroker, as bankers were known back then, instead of an Anglican priest. 2021 broke the IPO records in Finland with the previous record being set in the unforgettable boom year of 2000. Yet as all of us above the age of 22 know, all parties come to an end, no matter whether your dealer is Christine Lagarde or some dude off Silk Road. 2022 has so far seen five listings, of which only one took place after Feb 24. And while the brave men and women in the ECM teams are doing everything they can, the rate of IPOs in the next 9 months is unlikely to pick up.

    So, the stock market is off the table as an exit route, which in its way is unfortunate as at least 10 of the 29 listings last year had a PE backer. However, it is not all negative. Many of the listings in the past 18 months would have made a fine buyout target had the multiples been more, shall we say, cashflow-based. We’ve already seen two public-to-private transactions this year (Basware and Avidly). Now that the valuations have come down, will there be even more?

    Inflation is a curse – inflation is a blessing

    One question that has been consistently on investor’s lips when we’ve discussed new assets over the past few months is: “How is this impacted by inflation / downturn / interest rates?” Not surprisingly, often times the answer is: negatively. Whether its consumer goods being hit by decreasing spending, construction firms being crushed by slowing volumes and rising prices, or infra-assets facing the squeeze of rising interest rates, the current climate is not the easiest one to operate.

    Then again, as Goethe put “Where the light is brightest, the shadows are deepest”. Those companies who are less affected by the three above-mentioned horsemen of the apocalypse (Wonder what the fourth would be? Covid-rebound?) are doing rather nicely or even benefiting. Firms that generate steady cashflow have become very attractive alternatives. They are not at the mercy of discounted cash flows and are thus able to pass on cost increases and operate preferably in the B2B sector. A mature B2B SaaS business, or energy-related services anyone?

    Dude – where’s my funding

    Last year was a record one in fundraising as well, as Finnish buyout funds raised a record 1.4 billion euros[i]. Listening to the news it’s clear we’re not going to see that level surpassed this year (for what it’s worth, the previous record was from 2007 so it took 14 years to break). However, the Finnish buyout funds still have a total of 3.0 billion euros dry powder. Given that the average investment flows have been 250-500 million euros, it is obvious that a short slowdown in fundraising will not affect deal flows.

    What might have a bigger impact is the availability of bank finance. As interest rates rise and banks realize that they can make money through the good old lending margin, it will be interesting to see whether they still see the role of leveraged finance as previously. However, even if the lords of finance decide to shun the lowly buyout deal, all is not lost. Private debt raised a record 222 billion USD globally last year[ii] (no Finnish stats, sorry!). And those funds have a much narrower mandate than your average bank portfolio. But the terms and price of that debt will probably be something different from what we’re used to seeing.

    Sharp winds make for fast turns

    So how does the future look like? With listings not (easily) available as an exit route, emphasis being put on profitability rather than growth and debt funding being less easily available, it is clear that the environment in the next 1-2 years will look different than previously. But the shift also presents opportunities with lower entry multiples, potentially distressed owners, and fewer buyers. Or as the Oracle of Compton put it: “Today, I didn’t even have to use my AK. I gotta say it was a good day.”