With pressure mounting on private equity funds to show profits, many are pushing through share sales of the companies they own even as market conditions remain far from optimal.
PE-backed companies represented 17% of the follow-on share sales in the second quarter, up from only 6% a year earlier, according to data provider Dealogic. There were 27 deals worth US$5.3 billion last quarter, up from eight deals totaling US$1.2 billion in the year-earlier period.
“Funds need to recycle capital,” to show they can make profits and attract new investments, said Daniel Klausner, head of equity capital markets advisory at Houlihan Lokey. “They have been having a challenging time fundraising, as we are no longer in a zero-interest rate environment.”
While follow-up share sales have picked up, they are probably not going at the pace private equity funds need to show meaningful gains to investors. It used to take 12 to 18 months for a fund to fully unload its shares in a company after going public. But high volatility virtually shut down the IPO market for much of the past 18 months and disrupted the rhythm of follow-ons.
“We see a lengthening in the supposed year-and-a-half period after-IPO monetization period,” said Steve Slutzky, co-head of Debevoise & Plimpton’s Capital Markets Group. “Private equity funds have to wait for the right money market conditions, and have to coincide with earnings. It is not as easy as it had been.”
With a lack of realized gains on their investments as proof of their capabilities, PE firms have a tough time convincing institutional investors like pension funds and endowments to fork over fresh capital for their latest funds. That’s exacerbated by the fact that institutional investors have an overexposure to private equity after last years’ inflation-fueled market swoon.
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The delay in public market exits and the resulting longer hold periods create another headache: The profit margins of many of the companies they own are being squeezed by higher interest rates.
“We’re in a higher rate environment and some of these private companies are levered five and six times,” said UBS AG’s Brad Miller, head of US equity capital markets syndicate. “If that debt maturity comes due, companies would have to refinance at 200, 300 basis points higher than where the historical debt was, which is going to have an impact on your net income.”
As a result, PE firms are getting creative. For example, when Clayton Dubilier & Rice winnowed its position in Agilon Health Inc. in May, the PE firm agreed not to sell its remaining 24.7% stake for 900 days so it didn’t inundate the market with stock and depress prices. The wait for follow-ons is typically 30-to-60 days.
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Private equity funds also are increasingly selling their stock back to the companies themselves, said Eric Juergens, a partner at Debevoise & Plimpton.
“It allows the company to get a big chunk of shares back, and allows the PE sponsor to sell shares without selling into the market,” Juergens said.
Looking ahead, there’s still a lot of pent-up demand for private equity funds to sell down their holdings. Nearly 200 private equity-backed companies listed in the US in 2021, and 51 more followed suit last year, Preqin said. Almost all of them will be prime candidates for follow-on deals.
