Private Equity Bulletin 20 April 2020

h2glenfern Covid-19 Market Round-Up for Private Companies

Following our round-ups of the broader equity market implications of Covid-19 for listed companies, we have compiled this bulletin in response to requests for a similar summary on private companies and investment therein. While it is initially written for our clients, please feel free to circulate it to any of your colleagues and peers who you feel may find it of some use.

We summarise what we see as the key issues under six headings below.

1. Economic activity in the UK and globally (dramatic decline)

All will be aware of negative impact Covid-19 is having on economic activity and we now have data confirming the scale of the slow-down in March. For example:

  1. UK consumer confidence fell to its lowest level since 2008 in the final two weeks of March. The survey by GfK showed a balance of -34% thought the outlook negative, the lowest since -39% during the GFC and down from -9% in the first two weeks of March.
  2. UK business confidence fell 21.69 points in March to 79.95.  This is the fastest one month decline since BDO started recording the data 15 years ago and is equal to the cumulative decline seen in the 2008 financial crisis.
  3. The IHS Markit construction PMI in the UK fell from 52.6 in February to 39.3 in March, its steepest one month decline since April 2009.
  4. Across the Eurozone, the construction PMI fell from 52.5 to 33.5, the steepest fall since Feb 2009.
  5. Germany’s IFO Institute reported its index of production expectations has fallen from +2.0 points in February to -20.8 points in March.  This is the largest one month drop recorded since the survey was first conducted in 1991.
  6. US unemployment rose from 3.5% in February to 4.4% in March.  22m jobs were lost in the in the four weeks to 11th April.

The scale of economic consequence is vast and only beginning to emerge. Among private companies such well known names as Neiman Marcus, the US retailer, and Cirque du Soleil are considering filing for bankruptcy.  OneWeb, which has already launch 64 satellites as part of its network to provide global internet access, has blamed Covid-19 for its failure to secure new funding and consequent bankruptcy.

2. Transaction Activity (on hold)

Every one of the private M&A transactions in which h2glenfern is involved has paused.  While a few mid-market transactions have completed (e.g. Stirling Square’s purchase of Assistansbolaget, Nordic Capital’s purchase of SpaMedica from CBPE, YFM Equity’s sale of GroupBC, Elysian Capital’s sale of Wellbeing Software), much of the market has ground to a halt. Private Equity Wire estimates that 90% of PE deals are on hold globally.  The inability to conduct face-to-face meetings places an obvious brake on any process but the two principal concerns of buyers in this environment are:

    1. Availability of finance
    2. Valuation – how are future cashflow and earnings affected?

Reports by the likes of Bloomberg and Abacus Finance say that the requirement for PE sponsors to keep existing portfolio companies afloat is trumping their ability to make deals.

Examples of transactions that have been postponed include CVC’s £300m acquisition of Six Nations Rugby, Wal-Mart’s planned sale of Asda, valued at c.$7bn, having allegedly had bids from three PE firms, EQT’s sale of IFS ($3bn), Bridgepoint’s sale of Rovensa ($1bn), KKR’s sale of Goodpack ($2bn) and Smiths Industries’ sale of its medical equipment subsidiary ($3bn).  The National Bank of Greece pulled its sale of Ethniki Insurance after receiving bids below its estimated €600m valuation (CVC is rumoured to be a bidder).

Airbnb provides an up-to-date example of valuation change: it has just raised $1bn in debt and equity from Silver Lake and TPG Sixth Street Partners that valued the company at $26bn, 16% lower than the $31bn of the last round of VC funding in 2017.

Abacus reported that loan pricing has risen by 100-200 bps since the pandemic started and leverage has compressed at least 0.50x from its level at the start of March.  In addition to an estimated €370bn of leveraged loans that need repaying by private investors in Europe, Bloomberg cited a report by Investec that estimated European PE assets could decline by 50% in value by June.

First hand feedback suggests that some sponsors will address doubts over valuation by slowing processes investigating potential new investments.

3. Credit availability (a mixed picture)

Press and first hand reports suggest that loan finance is still available for private M&A but that uncertainty about its specific availability and pricing has increased significantly.  In a report published on 6th April on trends in European debt markets, Lincoln International noted the following:

    1. Lenders are honouring existing commitments.
    2. Debt and equity investors are cautious in reviewing new opportunities.
    3. Government measures alone are unlikely to be sufficient for most companies requiring additional finance and the mechanism of government support is untested.
    4. Since the start of the crisis they estimate a 150-200 bps increase in the indicative margin for subordinated debt and 50-150 bps increase in indicative margin for the first lien.

The situation for start-ups appears to be tougher.  Sequoia Capital, for example, wrote to its portfolio companies last month noting that “private financings could soften significantly as happened in 2001 and 2009”.

In contrast to Europe, Abacus Finance reported that private credit and LBO activity for mid-market transactions in the US has come to a halt.

In terms of the availability of government loans to private companies, the situation in the US and Europe are also completely different.

In contrast to speculation at the end of March, small companies backed by PE and VC firms in the US have effectively been denied access to $350bn of government rescue loans. Although the situation may yet change, this is because $350bn of the $2tn rescue package is assigned to companies with fewer than 500 workers.  Companies backed by PE and VC groups must include all employees of the group in their count.

In Europe private companies sponsored by PE and VC groups, in general, can apply for support loans from the government.  There are differences between countries in the speed and quantum of support available. 

France and Germany have already enacted plans to use state aid as a liquidity bridge for smaller firms.  France has made €4bn available that includes short term refinancing and early issuance of tax credits.  Germany is using VC firms to distribute €2bn to struggling start-ups and will enable the KfW Group and European Investment Fund to use public capital to replace money withdrawn by other investment funds.

The UK government has been criticised for its sloth and the complexity of the support plans it has put into place.  Initially there were two support plans available: the ‘Coronavirus Business Interruption Loan Scheme’ (CBILS) for ‘viable’ companies with turnover of up to £45m and the ‘Covid Corporate Financing Facility’ (CCFF) for investment grade companies with turnover greater than £500m. 

By 14th April, the CBILS programme had provided about £1.1bn in funding to 6,016 firms (of 28,460 formal applications). It provides loans of up to £5m over the next five years but it was not clear if ‘viable’ meant loss-making companies were ineligible.  Initially applicants had to have made a commercial loan application first but that requirement has now been deleted.  By 3rd April the CCFF had provided £1.9bn in support and had committed a further £1.6bn.  It provides loans for up to 12 months by enabling the Bank of England to buy applicants’ commercial paper.  EasyJet raised £600m in this manner on 6th April.

For companies with turnover of between £45m and £500m there was no facility until the ‘Coronavirus Large Business Interruption Loan Scheme’ (CLBILS) opened on 20th April enabling companies to apply for up to £25m. On 21st April UK Finance announced that CLBILS facilities will be available to non-investment grade companies with sales over £500m ineligible for CCFF loans.

Concern about the lack of government support for start-ups was exemplified by the ‘Save our Start-Ups’ campaign led by crowdfunding platform Crowdcube in early April. It gathered more than 2,000 signatures from the likes of Draper Esprit and Q Ventures in a petition. On 20th April, the UK government announced both the launch of the Future Fund and that PE and VC-backed companies with revenue below £45m can access the CBILS scheme. The Future Fund pledges £250m from government matched by another £250m from private investors to companies who have raised at least £250,000 in private investment in the last five years. Loans from £125k to £5m convert to equity in the companies’ next funding round.

4. Fund raising by investors (successful closings and broad optimism)

Initial reports suggest that fund raising by investors in private companies has not suffered from the hit evident in the real economy or performance of stock markets.  Post-Covid-19 news includes CVC closing its latest Asia Pacific Fund with $4.5bn raised; Insight Partners has raised $9.5bn for its eleventh tech fund; CVC is aiming to raise €20bn for its eighth flagship buyout fund and Silver Lake is gearing up to raise $16bn-$18bn for its sixth flagship fund.

The strong performance of the PE asset class relative to other investments over the past two decades would seem to explain this.  Investors probably hope that the industry has learned from its experience during the GFC when some portfolio companies were over-levered and the fact that on this occasion loan finance continues to be available.  Indeed, the current disruption in markets would normally offer a great opportunity to PE investors but given our recent inexperience of crises such as this, it is hard to consider this situation in any way normal. Data from Pitchbook shows that 2019 was a record year for PE fund raising and even before Covid-19 struck, they were forecasting a year-on-year decline in 2020.

A recent survey by Pitchbook (3rd April) shows surprising positivity.

  • Only 61% of respondents expected a large or medium impairment to fund raising.
  • Travel restrictions are a major issue.
  • LPs appear more comfortable with remote working than GPs.

5. Reputational risk (ESG policies driving management behaviour)

Both senior management of private companies and investors in those companies are most likely aware of the reputational damage that the financial sector suffered in both the aftermath of the dot com boom and during the GFC.  The perception of a financial system that ‘socialises corporate losses while privatising the gains’ and the rise in importance of good corporate governance and ESG criteria (environmental, social and governance) among investors, regulators and other stakeholders in companies must be appreciated.  Concern about the ‘socialisation of corporate losses’ may have been a contributory factor to the current exclusion of PE and VC-backed companies from US government support.

Recent announcements by listed companies related to the impact of Covid-19 provide templates for both good and bad senior management behaviour.   Issues that they address include the health and welfare of all stakeholders, action taken to establish the state of the company’s market and its financial position followed by action to provide financial support if necessary.  Board and senior team remuneration have been a key issue, especially when cost cutting has led to employees being made redundant, furloughed or their salaries reduced. In many cases dividends have been cut and guidance for 2020 suspended.

Board and senior management are expected to share any financial hardship that employees experience.  Since mid-March we have read 50 RNS statements in respect of Covid-19.  28 of them described reductions in senior executives’ salaries of 20% or more and 25 of them reductions in NEDs’ fees of 20% or more.  Strong examples of good behaviour include Computercentre, whose CEO and FD have elected to reduce their salaries to zero until 30th June in solidarity with furloughed colleagues; Sabre Insurance, who have offered paid leave to employees who want to volunteer for the NHS. In contrast WH Smith, has made redundancies and cancelled the interim dividend but made no change to executive remuneration, whilst the Premier League seems to be in ESG paralysis.

Companies that maintain dividends must be able to show that they are generating adequate cashflow and operating well in the current situation.  Any suspicion that a company that takes money from the government passes it on to shareholders is bound to be punished in future.

Among investors in private companies, concerns about Covid-19-related declines in valuations of companies they are already in the process of assessing for investment are balanced by an awareness that they do not want to be seen to be profiteering.  This is likely to be a contributory factor to a delay in deal completion as both parties try to assess the likely impact of Covid-19 on the company and its market.

Another potential issue is the societal impact (the ‘S’ in ‘ESG’) of the limited availability of credit.  Our contact with PE investors suggests that most have advised their portfolio companies to draw down the maximum amount available to them through revolving credit facilities.  In a similar vein announcements by public companies imply that many are accessing available lines of bank credit whether they need them or not.  If a significant credit crisis subsequently emerges, those companies that did not really need the credit are likely to be harshly judged.

6. Outlook and future opportunities

While we cannot be sure when the pandemic will pass, some investors have ventured opinions on when confidence will improve. When asked by Private Equity Wire, both Joerg Zirener of One Equity Partners (USA) and Lars Dybkjær, managing partner of GRO Capital (DK), said that they regard a slowing in the growth rate of new infections to be key.

In addition to the fund raisings described above, the current turmoil is bringing forward the opportunity for certain sectors.  Biotech PE funding seems to be marching ahead: on 5th April Pitchbook reported that ARCH Venture Partners has just raised $1.46bn for two funds and that Flagship Pioneering had raised $1.1bn.  There was even an IPO: Zentalis Pharma listed on NASDAQ on 3rd April having raised $165m.  It rose 29% on its first day of trading. 

David Mussafer, the chairman of Advent International, highlighted the opportunities Covid-19 offers his investors to get involved with excellent businesses who have not previously considered raising capital from them.  In an interview with the FT he emphasised Advent’s interest in the tech, healthcare and consumer sectors.  James Brocklebank, head of Advent’s London office, said that the firm has held back significant funds from their previous funds.  This enables them not only to support their existing portfolio companies but also the chance to undertake M&A at attractive valuation multiples.

Tech is a theme rather than a sector, but its utility has been re-emphasised by the constraints placed on us by the pandemic. Any future reluctance of workers to travel, whether for health or environmental reasons, should benefit tech.  Hence it is unsurprising to hear about Insight Partners’ closing of their $9.5bn raising for their eleventh tech fund or Lilium, an electric, autonomous, flying taxi start-up raising $240m from existing investors two weeks ago.  The pressure placed on supply chains by personnel shortages and higher barriers to international trade as a result of the pandemic serve only to heighten awareness of the importance of tech in improving their flexibility.  As more consumers opt for digital-only financial services, fintech start-ups could reap long term benefits from the Covid-19 ordeal. Circumstances may prove the advantages of alternative ways of working and communicating, presenting longer term benefits for some organisations.

Staffing is a perennial issue in healthcare; in hospitals, care homes but even in companies we know running telehealth and remote care businesses. LaingBuisson has reported that the care home sector employs 1.6m, normally has 122,000 vacancies at any one moment but during this crisis could lose 30%-50% of care home staff (according to SP&P, a consultant to the care home sector).  Prof Martin Green, CEO of Care England, has said the government should change legislation to allow furloughed staff from other sectors to move into social care roles while still receiving their government allowance covering 80% of their salary.

In spite of these concerns, Lincoln International delivered a report at the end of March suggesting that the pandemic is likely to accelerate the popularity of recent trends seen in healthcare:

      1. Critical diagnostics tests
      2. Lab testing infrastructure
      3. Telehealth and remote care
      4. Patient centricity and specimen logistics
      5. Patient engagement and healthcare consumerism
      6. Patient-directed home care providers

In January China was the first country to be hit by the pandemic.  After a dramatic decline in VC activity in January and February, PitchBook reports a recovery in March.  Although uncertainty reigns about the durability of this recovery, it provides some encouragement for European and US markets. 

In terms of the attractiveness of private company opportunities in Asia, I refer you back to the successful recent fund raising by CVC of their latest Asia Pacific fund.  On 27th March Reuters reported that China-focused buyout funds had already raised $6bn compared to $1.3bn over the same period in 2019.  Hu Xiaoling, founding partner of CDH Investments, has estimated that 70%-80% of private enterprises founded in China in the 1990s are short of qualified successors.  Founders are increasingly open to selling to PE sponsors with strong operational capabilities.

Conclusion

Although the implications of the Covid-19 pandemic are still emerging, we can draw the following conclusions at this stage:

  • The pandemic’s economic impact has been huge; the greatest negative shock since the GFC and by some measures the greatest since the 20th century.
  • The Covid-19 shock is different from previous crises. Particularly notable is that loan finance remains available.
  • Private company M&A transactions have paused but generally have not been cancelled.  While loan finance remains, the ending of lock-downs in Europe and the US should enable commerce to recommence, valuations to be recalculated and many transactions to resume.
  • Existing trends in markets are likely to be accelerated by the economic shock induced by Covid-19.  These trends are not only operational themes, such as the rise of online activity and limits on carbon output, but also investment themes such as the rise of ESG criteria and the requirement for top notch corporate governance.
  • Public companies provide a useful model for the management teams of private companies to see what behaviour is and is not acceptable in the eyes of stakeholders in the 2020s.
  • The rise of ESG criteria and consequent shift of investors’ focus from public companies that maximise returns to those that provide sustainable returns in a manner that gives them a purpose in society favours a longer term outlook than many had over the past 40 years.

Contact Details

Tim Huddart (timht@h2glenfern.com) 07775 822711

Clive Anderson (clive@h2glenfern.com) 07775 822737

John Pickard (john@h2glenfern.com) 07552 461451

James Blackburn (james@h2glenfern.com 07887 844864

Michael Ansell (Michael.ansell@h2glenfern.com) 07540 836873

Tom Chetwood (tom@h2glenfern.com) 07921 455820                        

Michael Wills (michael@h2glenfern.com) 07885 406087

Deirdre Bellingan (Deirdre@h2glenfern.com) 07824 171098

Natalie Crisp (natalie@h2glenfern.com) 07415203194 

Julia Kavvadias (julia@h2glenfern.com) +491726874918

Remy Dumoulin (Remy@h2glenfern.com) +33621061018