June 2, 2020
The last few months have seen our Private Equity clients knee deep in resolving performance impairment and liquidity issues within their portfolio of assets. However, now and with most of the fires extinguished, those portfolio assets are falling into three main camps:
1. Good businesses trading strongly
2. Good businesses that, due to the exceptional nature of the market, are trading below par but expected to bounce back quickly post-crisis; or where the impact of social distancing is forcing a rethink of the business model e.g. a rapid move to digitalisation
3. Poor businesses that are not going to make it
Most of what can be changed, has been changed; daily update calls with the leadership teams of the portfolio business, and sharing of best practice across the portfolio, are now the norm.
At Drax we have seen a lot of changes to the CFO position. First time PE CFOs have struggled to deal with the combined pressure of performance impairment/liquidity and increased PE scrutiny; many Chairs have found themselves much more involved in their businesses than they ever anticipated, leading to some, but not widespread, changes. Conversely, without the PE House wanting to reset the clock for exit, few CEOs have been changed, so far.
What we have seen though, are thoughts turning to deal origination and challenging the standard concept of how private equity firms source deals.
Currently it’s fair to say that there is a scarcity of deals, with deal flow down significantly (figure 1). As I write this article, there are currently 38 deals across 68 potential investors, a drop to about 20% of the “normal” market volume.
Figure 1 UK PE Transaction Volumes by month
With assets being managed as best they can in the circumstances, and the emphasis shifting away from the immediate issue of crisis management, this now allows a lighter touch to support leadership teams working through the Covid challenges. There is now unusually, the luxury of time to reflect on how deals are sourced and valued. Here within the Leadership business of Drax, we have seen a subtle change in the attitude of our client base, and a shift in the market, away from preconceived ideas of how PE firms position themselves regarding deals:
1. Adopting the Operating Partner model. We have seen a lot of interest from PE firms in helping them to identify Operating Partners (CEOs) with strong networks, to actively “shake up” the market and unlock potential deals, where previously this model did not exist within that particular PE House.
2. Deep Dive. These market conditions are being seen as an opportunity for a “deep dive” into certain sectors, and to map these sectors out thoroughly. The belief is that by having an accurate sector map going forward, these areas will see growth in the future. Powered by leadership analytics tools such as drxDATA, we are supporting our clients to identify and meet with CEOs and Chairs, to better understand these sectors and explore investment potential. Mat Cuthbertson, Partner, Financial Services at Drax elaborates: “Due to the lack of formal processes and the shift from addressing short-term portfolio needs, investors have more time than they ever have to think about the future and specifically, their origination strategy. We are seeing a number of funds utilise this time to think differently about their sector approaches and the way in which they can source deals going forward. Combining Drax’s sector knowledge with the capability of drxDATA means we can assist investors on their sector ‘deep dives’, whether that’s identifying targets or building their network with Founders, CEOs and Chairs in areas of interest:
Figure 2. An example of a sector deep dive segmented by ownership type, scale, shareholder structure and propensity for change
3. Carve-outs. Another approach, rather than go through a detailed market mapping exercise, has been to look at carve-outs of larger groups or to take a minority interest stake to deploy equity and dry powder. Again, tools like drxDATA can pinpoint those businesses with significant leadership change, business disruption, over-zealous M&A, change in valuation, or owner/founder sentiment that would make these organisations more susceptible to a carve-out or minority stake.
Managing Director – Leadership