Private equity’s capitulation is delayed, not cancelled

Private equity employs a lot of clever people. In recent times, they have applied their brainpower to avoid having to sell assets at cut-price valuations. Bloated portfolios and high debt costs have been ratcheting up the pressure on sellers. But a fortuitous opportunity to refinance and extend leveraged loans has given the industry a chance to kick the can further down the road — and hope markets recover in the meantime.

The industry’s latest reprieve comes courtesy of the booming debt market. Investors are keen on high yields. Banks are slugging it out with private credit funds to provide financing. The result is that spreads on US term loans have tightened by almost 100 basis points in the 12 months to March, according to PitchBook LCD data. Activity in the US leveraged loan market has topped $300bn in the first quarter of 2024 — the vast majority are opportunistic swoops to refinance, reprice and extend the maturities of existing debt.

This wave of refinancings buys the industry some breathing room. It follows on from a whole series of wheezes aimed at delaying their day of reckoning. Continuation funds have given firms the opportunity to shuffle assets to a new group of investors and offer the previous lot an exit. Net asset value loans — where a firm raises debt secured on its entire portfolio, rather than on a single company — have provided a way to keep feeding capital to companies that need it.

Buying time is not as dubious a strategy as it might sound. Public market multiples have improved, albeit driven by a small number of stocks. The European initial public offering window has tentatively opened, although mainly for slam-dunk equity stories such as Switzerland’s Galderma. Lower debt costs will improve earnings, and a longer lead time gives the private equity industry time to grow companies into their valuations.

But none of this changes the basic physics of this market. The industry has amassed $3.2tn of assets, says Bain. Holding periods are increasing. And exits in the first quarter of 2024 only amounted to $81bn, down 22 per cent on the first quarter of last year, according to S&P Global Market Intelligence.

The pressure to return money to investors is rising, not least to provide them with capital to recycle back to the industry as it tries to raise new funds. While efforts to delay exits may help firms avoid the worst of a crunch, the day of reckoning still beckons.

camilla.palladino@ft.com