By Patturaja Murugaboopathy
(Reuters) - Dealmaking by private equity firms hit its lowest in four years, under pressure from high interest rates, recession fears, and a weak outlook for corporate earnings, although some analysts predict stored-up funding will drive a near-term rebound.
Private equity deal volumes slumped 63% from the same period last year to $293.5 billion, data from Dealogic showed.
Higher borrowing costs have led private equity to pursue fewer deals and avoid businesses with unpredictable cash flows.
Since the start of the year, buyout firms have been unable to secure cheap debt and have had to draw on their own funds, marking a departure from traditional leveraged buyouts.
"Rising interest rates have made private equity deals more expensive. Inflation has cut into target companies' profit margins," said David D'Urso, a partner at U.S. law firm Akin Gump Strauss Hauer & Feld. "Sellers are still expecting 2021-type valuations, which is not possible (due to the above reasons)."
Some analysts said an unfavourable market for initial public offerings (IPOs) contributed to the slowdown as private equity firms found it harder to exit investments.
This has complicated the financing environment for companies and startups that typically get bought or rely on funding from private equity firms, when banks have also slowed down corporate lending, analysts said.
"The implication for companies seeking private equity funding is simply less capital to go around, which could cause the weaker companies with short cash runways to be unable to continue operations," said Matt Farrell, senior investment manager at WE Family Offices.
Faraz Shooshani, a managing director and senior private markets consultant with Verus, said late-stage startups have been hit especially hard.
"Later-stage startups were wired to grow at all costs prior to the downturn. Many of these companies have cut down on their cash burn rates. The few that get funding get it at much lower valuations than pre-downturn," Shooshani said.
UP TO 80% SLOWDOWN
U.S. deal volumes more than halved to $162.5 billion from last year, while activity in Europe and Asia (excluding Japan)fell 70% and 80% to $77.3 billion and $19.1 billion respectively, Dealogic data showed.
Technology deal volumes fell by 75% to $16 billion, while healthcare and finance sector deal volumes dropped 70% and 64% to $8 billion and $7.6 billion respectively.
Fundraising by buyout firms has also declined this year as limited partners have reduced their backing. Limited partners are investors who allocate capital to private equity firms.
Private equity funds have raised $325 billion so far this year, compared with $459 billion during the same period last year, data from Preqin shows.
The boom in private credit, however, boosted private equity firms, as they stepped in to issue debt to companies after traditional lenders withdrew. An increase in direct lending helped to mitigate some of the risks associated with equity investments, as private equity firms benefited from consistent and stable returns.
Timothy Tracy, global client service partner at EY, said financing for US and European deals from private credit funds has increased significantly.
"The dramatic rise in private credit has been largely driven by the tighter lending standards that banks implemented to reduce their exposure to large leveraged loans as well as by recent bank failures which allowed private credit lenders to fill the void," he said.
Some analysts expect private equity dealmaking to bounce back in the near term, as buyout firms have yet to deploy a portion of the funds they have raised over the last two years.
"As we work through the interest rate cycle and the broader economic cycle, transaction volume will eventually increase," said Jordan Tate, managing partner at Montage Partners.