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Private equity state of the market

Why operational improvements are the key levers of choice for general partners.


September 25, 2023

This year we’ve witnessed a calming of the highly turbulent market of 2022. Following an increase of more than 500 basis points in interest rates by the Federal Reserve and other central banks, the macro situation stabilized as inflation cooled off from its highs of 8-10% to 3-6% globally.1 However, resilient wage growth and a tight job market along with sticky core inflation have kept major central banks vigilant and determined to keep interest rates higher until inflation returns to its target rate of 2%.

The M&A environment is tepid at best. Compared to the same period in 2022, worldwide M&A value decreased by 37% in the first half of 2023. And while still ranking as the fourth largest opening half of the year on record, Private equity (PE) backed M&A value declined by 49% in the same period.2

PE continues to be an attractive asset class overall. The number of active firms continues to increase with assets under management up 50% since 2019 and dry powder being near record highs.3 As PE funds proliferate, general partners (GPs) are not only competing against their fellow generalists. They’re jockeying specialist firms that take a different approach to investing and value creation.

An increasing amount of capital is chasing a limited number of deals and targets. As a result, multiples have been slow to adjust to buyer expectations. In this environment, financial engineering levers are taking a back seat to operational value creation levers as firms are holding assets longer and leaders look to drive more fundamental interventions. This is clear in three trends we’ve seen play out.

PE leaders believe 75% of their efforts should focus on operational value creation.

1. Tight credit conditions persist, along with rising cost of capital

In a tight credit environment, the surging cost of floating rate debt pushed up the cost of capital for PE-backed companies substantially (10-11% for B-rated leveraged loans), (figures 1 and 2).4

Figure 1: Leveraged loans insurance for buyouts.
Figure 1: Leveraged loans insurance for buyouts.
Figure 2: Benchmark rate and yield to maturity for B-rated leveraged loans
Figure 2: Benchmark rate and yield to maturity for B-rated leveraged loans

Pitchbook data shows that, as a result, the average share of debt to EV in LBO deals has fallen to 43.3%, from a five-year average of 52.2% (figure 3).  Silver Lake’s recent buyout of Qualtrics from SAP had a debt component of less than 10%. As interest obligations increase, sponsors need to use operational execution to manage cash better for their portfolio companies.

Share of debt in EV
Share of debt in EV

In our Conquering the Next Value Frontier research, we surveyed 170 PE leaders who told us they want to lean more on cost management and cash benefit levers than before. PE leaders want to place ~10% more effort on these value creation levers.

Levers like cash management, working capital improvement and global business services are higher-impact/lower-difficulty levers and are being used most often.

2. Increases continue in middle-market deals and smaller/bolt-on acquisitions

The share of add-ons in all PE buyouts climbed to an all-time high of 78% as of H1-2023, expanding 600 basis points since 2022 (figure 4).  The share of smaller deals, between $100-$500 million in value, is also up at more than 50% of all PE deals (figure 5).

57% of PE firms we surveyed engage in add-on deals. Of those, 59% expect deal volume to increase over the next five years, while 61% expect to increase capital allocated to these deals.

Figure 4: Add-ons volume and % of buyouts
Figure 4: Add-ons volume and % of buyouts
Figure 5: Deal value by size
Figure 5: Deal value by size

As more of these “buy-and-build” assets get acquired in a shorter timeframe, the importance of integrating them effectively into the value creation game plan goes up. PE leaders need the right operating model, customer strategy, pricing and servicing model, distribution/sales channels, and services portfolio to spur growth while driving lower operating cost to serve and realizing overhead cost reduction.

PE firms are using revenue levers like product line expansion, geographic expansion and marketing optimization, and are implementing cost levers like vendor selection and inventory optimization to capture the full potential of the synergies involved.

Seventy-three percent of sponsors doing carveouts expect volume to increase over the next five years, and 69% expect allocated capital to increase.

3. Complex deals remain on the upswing

GPs are increasingly leaning into corporate carveouts and divestitures as companies shed non-core assets to strengthen balance sheets. Carveouts made up 10.3% of all buyout deals in the US in Q2-2023, up from 6.2% in H1-2022.7

Sponsors are not only looking at carveouts as standalone targets, but also at their own portfolio for carveout-related opportunities. Apollo´s carveout of ADT´s commercial unit to GTCR in August 2023 and PE-backed Endeavor’s carveout out of IMG Academy to EQT in June 2023 are prime examples.

Pulling the carveout lever in your own portfolio can be overlooked due to the complexities that often come with them, including a multitude of post-divestiture agreements, operating model challenges and legacy tech stacks. As action increasingly shifts towards using this lever, the right approach to solve operating and technological challenges can unlock trapped value.

Success depends on accelerating growth by driving broader realignment towards higher growth and margin areas, realigning organizational structure, and transforming the digital and tech capabilities at the core of the company.

In our research, PE firms listed IT and tech improvements as the most frequently used value creation lever for carveouts, followed by cash management, headcount optimization and asset efficiency increases.

The underlying theme of the current state of markets is clear:

  • The PE markets continue to normalize from the lows of 2022, with some sectors showing increasing signs of a pickup in activity.
  • Competition in PE remains high with an increasing number of PE firms and capital chasing a limited number of targets.
  • Incorporating deeper operating interventions alongside the more frequently used value creation levers is an effective combination to deliver improved outcomes for investors.
  • The focus is shifting towards deeper fundamental interventions to drive value creation in an increasingly complex deal landscape.

I’d like to thank Uday Khanna, Ben Liwnicz and Marty Glenn for their contributions to this article. We look forward to sharing more on our research into value creation levers and the implications for sponsors in an upcoming piece.


Jay Scanlan

Senior Managing Director – Global Lead, Private Equity