Excerpts from our conversations during this unprecedented quarter…
“Essential” Defined. While business attire hung deep in the closet through months of sheltering in place, innovation accelerated secular changes with a focus on essential services — condensing what may have been ten years of innovation into the next few. Private equity middle-market investing often gravitates to the word “essential”, a differentiator from public markets that support a greater percentage of fashionable, themed businesses. Some public new economy companies such as AirBnB and Uber along with entertainment and gig economies were forced to virtually shut, following the worsening health trajectory. Investors now have a deeper appreciation for the benefits of investing in the most essential sectors including healthcare, technology, education and supply chain management.
Digital transformation themes propelled more than just the K-to-12 crowd’s home learning. Technology adoption quickly facilitated remote healthcare, new media, social movements, workforce management and safety protocols. Better capitalized companies, as well as those that were able to pivot workflow and services, were best positioned to continue working, keeping their workforce intact with relative productivity.
Cash Creates Kings. Acquisitions that might not have otherwise occurred are expected as better capitalized contenders not only survive but thrive. On the horizon is a future of reduced competition and heightened pricing power, ultimately widening margins.
The next two quarters are expected to provide greater transparency on the actual valuation re-set. Small-buyout strategies and middle-market growth equity often benefit from lower levels of leverage and flexible work forces. That being said, concentrated customer bases and sponsors with smaller warehouses of dry powder will create winners-losers. This period has provided investors with the advantage of a live stress test and ample add-on supply.
“A downturn can be a very good time to build a company…the parvenus and pretender are gone.” Michael Moritz, Sequoia Capital
Financial services experienced heightened respect not seen since pre-2008. The rapid onset of the PPP (Paycheck Protection Program) and loan forbearance have temporarily supported cash flows but reserves and workouts are expected to increase through the balance of the year. Moody’s reported a larger expectation of loss-given-default following a decade of credit expansion. This time, however, the U.S. banking system is armed with ample reserves, having retooled since the last recession.
Price discovery will continue to roll out for the balance of the year. The greatest uncertainty is within real estate and consumer-exposed equity and debt. The monthly wait-and-see cycle will continue as the early rounds of stimulus wane and the remote workplace transition impacts real estate demand and transportation. Localized regulatory actions may drive uneven outcomes as selective rent forbearance policies are put in effect. While capital markets continue to gyrate, many appetizing transactions at attractive multiples, not seen for many years, are expected to materialize. The question is, which investors will feel emboldened to act earlier, facing the risk of a further worsening of the health trajectory?
Leaders, Stakeholders, Employees. ‘Values’ trumped enterprise valuations as CEOs, reacting to short-term shocks and health risks, took care of their people first. Leaders focused on how to support high performing teams during rapid changes to operational workflows and explored new depths to the conversation around safety and bias. Resilience and grit were tested this quarter. In this time of a deeply felt re-evaluation of bias and diversity, we remain proponents of the drive for an inclusionary world.
“The best memorial we can build for those who lost their lives…..is a greener, smarter, fairer world.” Kristalina Georgieva, IMF
For our part in this transformative environment, we remain focused on identifying talented, high-performing managers seeking capital to launch their Fund I. We look forward to your participation in creating these opportunities. Wishing you and yours well during these challenging times.