Article:

Six Private Equity predictions for FY23

29 July 2022

Sebastian Stevens, National Leader, Private Equity
Partner, Corporate Finance
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What trends do private equity (PE) fund managers need to be aware of as they plan deals, develop, and execute value creation strategies and exit plans in 2023? BDO in Australia provides six predictions for FY23 to prepare your firm for the year ahead.

  1. Supply chain issues will persist in the short-term, as businesses continue to play catch-up
  2. Inflationary pressures and rising interest rates will cause volatility and impact capital market transactions
  3. Amid record fundraising, leveraged buyout (LBO) volumes may be tempered by rising interest rates
  4. The Technology, media and entertainment, and telecommunications (TMT) and healthcare sectors will continue to be of particular interest for private equity
  5. Adoption of ESG and impact investing will gain traction
  6. PE industry is forecasted to continue growing faster than the economy

Read on below to learn more.

Prediction #1

Supply chain issues will persist in the short-term, as businesses continue to play catch-up

Disruption to domestic and global supply chains, and vulnerabilities exposed by the pandemic, have yet to completely subside. Despite businesses adapting their supply chain strategies to become more resilient, data from the Australian Bureau of Statistics (ABS) indicates approximately 37 per cent of businesses continued to experience supply chain disruptions in February 2022. While this figure is down compared to January (c.47 per cent), it remains elevated compared to April 2021 (c.30 per cent).

Additional factors causing supply chain issues include delays in the flow of materials and deliveries, and the rising cost of transport and logistics services. As such, we expect supply chain issues to persist in the short-term.

BDO’s Key Takeaways

Prolonged supply chain issues and rising costs will place a squeeze on margins achieved by portfolio companies. PE firms will need to identify and implement supply chain efficiencies, as well as deploy a variety of operational initiatives across their portfolio. This is critical to ensure supply chains are resilient and dynamic, rather than just low-cost.

Prediction #2

Inflationary pressures and rising interest rates will cause volatility and impact capital market transactions

Over the course of FY22, governments in developed markets, such as the US and Australia, exercised contractionary monetary policy - in the form of higher interest rates - to curb inflation. Following their most recent board meeting in July 2022, the RBA announced a 50 basis point increase to the cash rate – the third consecutive rise. Given the latest RBA forecasts in May 2022 point to inflation reaching 6 per cent in 1H23, and 4.25 per cent in 2H23, further increases in the cash rate are expected. The impact of these movements will continue to be observed in public capital markets, which have already experienced various selloffs in recent months. For private equity, these macroeconomic factors will result in a higher cost of capital and reduced company valuations.

BDO’s Key Takeaways

Although rising interest rates and inflationary pressures will undoubtedly increase the focus on effective diligence from PE firms in the short-term, they are unlikely to cause significant negative impacts on Australian PE investment and deal flow. We expect sophisticated investors within PE firms to look beyond short-term volatility, given their focus on long-term investment opportunities, typically within three to five years.

Prediction #3

Amid record fundraising, leveraged buyout (LBO) volumes may be tempered by rising interest rates

Traditionally, a significant portion of financing for private equity buyouts is in the form of debt, allowing for greater returns on exit. This was further highlighted in the low interest rate environment following the pandemic. However, as outlined in Prediction #2, central banks are increasing interest rates to combat upward inflationary pressures. The RBA is expected to increase interest rates up to 2.5 per cent in the short-term; a level which could be sustained for the medium-term.

BDO’s Key Takeaways

Buyouts generate strong returns by raising valuations, improving operations and through leverage. The future macroeconomic environment is likely to lead to lower valuations and reverse the trend of highly levered deals. Although dry powder committed for Australasia as at July 2022 was a record high at USD $15.8bn (Preqin), fund managers may need to consider leveraging risk when financing their deals.

Prediction #4

The Technology, media and entertainment, and telecommunications (TMT) and healthcare sectors will continue to be of particular interest for private equity

TMT has been the hottest sector by deal volume over the last three years, consistently representing a quarter of annual totals. There were 47 TMT deals in PE over FY22, with over two-thirds in the software sub-sector. Continued innovations in blockchain technology, peer-to-peer and business lending software, robo-advice, and regulatory technology will encourage private equity to continue investing in fintech companies for the foreseeable future.

Pharma, Medical and Biotech deals present an exciting opportunity to capitalise on gaps within medical device manufacturing, clinical trials, and drug manufacturing. Further, given the increasing attention on health, and the essential nature of healthcare services, these opportunities provide a level of resilience and security that fund managers value.

BDO’s Key Takeaways

PE’s attraction to the TMT sector will continue for the foreseeable future. Software businesses will continue to be highly attractive to PE due to their recurring-revenue model, relatively fixed cost base, and highly scalable and non-capital-intensive nature.

We expect the Healthcare sector to continue gaining traction, following increased post-pandemic PE involvement. PE firms will look to capitalise on sub-sector consolidation opportunities, with examples including Quadrant’s roll-up of radiology clinics, and more recently, Alceon’s roll-up of ophthalmology clinics and short-stay hospitals.

Prediction #5

Adoption of ESG and impact investing will gain traction

Sustainable business practices benefit businesses, investors, and funds in a multitude of ways. These benefits include mitigating risk whilst improving performance, as well as enabling a sustainable future for our communities and future generations.

BDO’s Key Takeaways

PE firms will continue to face pressure to report climate-related risks and consider ESG factors in their investment theses and strategies. However, many funds are not ready to accurately report on their impact or showcase their ESG strategies.

The definition of an ESG fund can vary from fund to fund and is subjective to what they define as sustainable. PE firms should clarify their definition of ESG both internally, and in an externally published report that also outlines their investments, activities, and goals.

Prediction #6

PE industry is forecasted to continue growing faster than the economy

The PE sector is in the growth phase of its life cycle and is forecasted to grow 5.9 per cent annually over the five years to FY26. This outperforms Australia's GDP, which is projected to rise 2.1 per cent annually over the same period.

BDO’s Key Takeaways

The Australian market, whilst small on the global scale, continues to be highly attractive to foreign investment. This is a result of Australia’s relatively underdeveloped PE market, combined with our reputation as an investor haven given our strong political and economic stability. Although we expect short- to medium-term volatility in public and private capital markets, business confidence and the ASX are anticipated to recover in the long-term. This provides an optimistic outlook for PE firms hunting for well-timed, profitable, and opportunistic exits.

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