Analysis

Experience keeps Central Europe’s private equity investors confident

Private equity confidence in Central Europe is feeling the squeeze of the Covid-19 pandemic, but there is room for optimism, according to Deloitte Central Europe’s bi-yearly Private Equity Confidence Survey.

While investor confidence dropped from 87 to 62 points between November 2019 and June 2020, the slump is less drastic than that of 12 years ago during the last global financial crisis.

While respondents to Deloitte’s survey expect economic conditions to worsen (68 per cent), a remarkable 13 per cent actually expect conditions to improve, up from zero per cent in the last survey. Respondents are also expecting deal sizes to decrease (43 per cent compared to 13 per cent six months ago) but more than half (53 per cent) expect them to stay the same.

But, most important of all, despite 30 per cent of respondents expecting returns to decrease, a whopping 74 per cent of all private equity investors still think that 2020 will nevertheless be a good vintage for them.

“Given the ongoing uncertainty which lingers over markets, as well as the omnipresent element of the Covid-19 crisis, we can only hypothesize that these current expectations are buoyed by one variable which was less present in 2008: experience,” says Mark Jung, Deloitte partner and Central Europe private equity leader.

According to Mr Jung, private equity deal makers in Central Europe have already weathered the great financial crisis of 2018, which leaves them with the know-how to navigate problematic market trends and crises.

“Simply put, the battle-hardened may be better able to keep a steady hand, identify opportunities – and capitalise on them,” Mr Jung adds.

The main reason behind investor confidence not suffering a dramatic hit could be that the Covid-19 related financial crisis is expected to create a buyer’s market. Nearly half (45 per cent) of survey respondents believe that vendors have decreased their price expectations over the last six months and over half (51 per cent) expect they will continue to do so.

According to the survey, the Covid-19 pandemic is accelerating market trends that were already present before the outbreak. A trend of pricing reduction was already present in Central Europe.

A study conducted by Clearwater International found that entry multiples (the price paid for a company in relation to a financial metric, most commonly EBITDA) for the CE region have dropped off from over 10x in 2018 to 9x in Q2 2019 and stood at 8.1x in Q1 2020 before lockdowns began.

“Even prior to lockdown, there were some signs of increased market concern over sustainability of market deal pricing in CE, and in global equity markets – which may have had a knock-on effect into private markets where PEs play,” Mr Jung tells Emerging Europe.

Furthermore, the private equity market in CE did cool off somewhat since its 2017 heyday which was marked by large exits, strong fundraising, and high levels of deal-doing. This is evidenced by the confidence index’s gradual downward trend since May 2018.

“The market has remained strong following a growth phase, however, we have observed a downward trend starting in May 2018. It has been reflected in the economic expectations of the CE PE investment community,” says Mr Jung.

But, buoyed by price reduction expectations and prior experience in the region, it seems that private equity investors plan to soldier on through any Covid-19 related crisis.

This is best seen in the respondents answers about investment focus. The ratio of new investments to portfolio management to raising new funds has remained nearly the same between November 2019 and June 2020.

Similarly, investment activities remain very similar, although a with a significant increase of those who expect they will be buying more and selling less, up to 62 per cent from 48 per cent six months ago.

According to Mr Jung, after a period of focusing on critical operational aspects of their portfolios such as cutting costs and managing cash, the private equity companies are ready to deploy some of their dry powder in order to weather the crisis.

“Market uncertainty has increased substantially due to the Covid-19 situation. However, this has also created opportunities,” Mr Jung concludes.

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