Inflation, tech valuation may hold back private equity’s pent-up demand

Technology and its adoption across industries like financial services and healthcare drove private equity to record heights last year, and ironically it may be technology investing that helps drive back valuations in the industry this year.

Private equity saw record highs of deal volume as well as fundraising and distributions. But overarching macro effects like rising inflation, supply chain disruptions and this year, geopolitical shocks are impacting valuations, which could slow private equity’s pace.

“Uncertainty is the word of the day,” said Hugh MacArthur, head of global private equity at consultancy Bain & Co. The covid lockdown, resulting inflation and supply chain disruptions, and Russia’s invasion of Ukraine have created an environment of uncertainty to which the industry must adjust.

“Uncertainty is not a great word in highly leveraged buyout investing,” MacArthur said.

As far as inflation, private equity adapted quickly in terms of reducing costs, MacArthur said. However, as inflation persists and permeates numerous parts of the economy, firms may test the limits of exactly how much cost increase they’ll be able to pass onto consumers without damaging their portfolio companies.

As well, impending interest rate increases that the Federal Reserve has signaled are coming will make credit more expensive and could cut into deal pacing. This could lead to a period of “value dislocation where sellers won’t want to sell at prices buyers are offering and buyers won’t buy at prices sellers are offering,” MacArthur said.

While private equity is sitting on high levels of unspent capital, firms may find they have to hold assets longer than anticipated to wait out some of the economic flare-ups.

Inflation has been hammering public tech stocks this year, even before Russia’s invasion of Ukraine. These public comps are driving down valuations in the private markets, which are expected to show up in future quarterly valuation marks for the end of the year, and the first quarter.

But, even with the pain being experienced by tech valuations, GPs’ focus on technology is not going away. Tech and tech-growth will continue to be main areas of focus for private equity, MacArthur said.

“The trend of private equity being more growth-oriented and more focused on tech is not going away any time soon … because of the short-term macro effects in the long sweep of the industry,” MacArthur said.

Tech was the word of the year in 2021. Bain & Co found that specialization, especially around tech, is part of a trend of GPs and LPs in search of diversification. This is reflected not just in buyouts, but in sub-asset classes like growth equity, infrastructure and secondaries, according to the consultancy’s global private equity report.

“The appetite for diversification has led investors to pump capital into areas they never would have considered in the past,” the report, published earlier this month, said. “New funds have sprung up to serve them, and older ones – particularly the large, diversified buyout funds – have pivoted accordingly.”

Overall, private equity deal value globally reached $1.1 trillion last year, doubling the 2020 total of $577 billion. The increase was driven by larger deals, not necessarily more transactions, according to Bain & Co’s report. Deal count globally jumped to 4,300 last year, up 16 percent from the prior year, the report found.

“The real impact came in the market’s broad middle, where the number of $1 billion-plus deals roughly doubled,” the report said. “That helped increase average deal size by 57 percent, pushing it past the $1 billion threshold for the first time.”

Deal volume was driven by take-privates, which accounted for $469 billion globally, a 57 percent one-year increase, the report said.