PitchBook News - What rapid inflation means for PE

Also: Insights into how LPs are thinking; Supply chain tech's decades-long opportunity; Understanding GP economics; Public PE firms take cautious tone
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The Research Pitch
June 11, 2022
Live indexes! We leverage a number of PitchBook's proprietary indexes to support our research. This week, we launched a live page to house that suite of indexes, including the post-IPO performance of former PE- and VC-backed companies. Check it out.

Catching up. We've been running an ongoing series of research on how the changing macro environment is affecting private markets. Here's a recap:
Tough times ahead for PE as inflation soars and monetary policy tightens
Recent market movements and economic data have signaled a shift in the underlying investment regime.

What does this mean for the macro outlook and PE?

The post-pandemic regime, characterized by near-zero interest rates, excessive monetary and fiscal stimulus, easy credit conditions, and manageable inflation, fueled an unsustainable boom in financial markets.

We think that the new regime will usher in a very difficult period for investors, highlighted by high inflation and a tighter monetary policy.

With inflation rising to a 40-year high, the market's expectation of the federal funds rate at year-end has increased by 200 basis points to 2.8% over the past six months.

While a federal funds rate of around 3% may ease some demand-side inflationary pressures, continued supply chain issues and a tight labor market represent supply-side constraints that could help keep inflation elevated, and in turn, force the Fed to hike interest rates more than expected.
Click for a bigger screenshot of our new recession model.

Despite the challenging environment, our economic modeling indicates there is only a 19% chance of a recession occurring in the next 18 months based on data available at the end of May.

However, the probability of a recession has been increasing in recent months and may continue to do so if interest rates and inflation rise further.

Rising interest rates present a significant threat to the buyout model, where deals are primarily funded via floating-rate leveraged loans.

Financing costs for single B-rated loans have already increased to 5.9% from a record low of 4.3% at the beginning of 2022.

This rise in financing rates would result in a 33% increase in interest expenses for a baseline buyout deal with a valuation of 12x EBITDA and a debt-to-equity ratio of 1.

To offset this increase and keep interest coverage ratios at acceptable levels, buyout investors will likely seek deals at lower valuations.

While PE dealmaking slowed to start the year, it remained well above both its short- and long-term trends, supported by near-record dry powder levels.

Exit activity, on the other hand, stalled from the frenzied pace experienced in 2021. PE investors are likely to face a much more difficult exit environment moving forward, exemplified by less liquidity and an increased focus on valuation by buyers.

For more analysis and data on the macro environment and its potential impact on PE, download the full report for free: US PE Enters a New Regime

Andrew Akers, CFA
Quantitative Research Analyst
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Thematic Research  
GP Stakes Fund Portfolio Construction

It might be more important than ever to understand GP economics, as many methods are available now to invest in alternatives managers.

Notably, GP stakes investment returns vary by the target firm's strategy, comparing buyout, growth equity, credit, real estate and infrastructure.
This chart looks very different for other strategies.

Well-rounded portfolios are best positioned to perform in all market conditions, but there's a lot of give-and-take involved.

Our research breaks down the impact of various factors including inflation, interest rates and volatility:
read the free research

Insights into LPs' Approach to 2022's Market Challenges

LPs and allocators are likely to take a breath during times of market volatility.

But how long that breath lasts can depend on factors such as governance and the portfolio's purpose.

Our new research explores how LPs are reacting to the new macro environment. Key highlights include:
  • Inflation and rising interest rates can damage returns, but LPs are targeting cash, real estate, real assets, and private debt as areas of relief.

  • Expect net cash flows to stay negative, which will hamper new fund commitments.

  • There's still plenty of dry powder to support existing portfolios, though that will vary from fund to fund.
read the free research

Analysis of Public US PE Firm Earnings: Q1

As the market turns, public PE firm executives have shifted their tone during earnings calls.

The mood is more cautious.

And firm leaders have been quick to highlight whether they have active strategies connected to floating-rate credit, real estate, and infrastructure—as LP interest grows in those directions.
Blackstone and Ares have grown the most, proportionally.

How are broader fundraising prospects looking? Which firms have greater access to capital from retail investors?
How are strategies shifting and stocks trading for PE's public giants?

We cover it all:
read the free research
Emerging Tech Research  
Reworking and reshoring global supply chains could be a decades-long effort.

But however long it takes, the opportunity led to significantly larger investment flows into supply chain tech last year, and while deal volume slowed in Q1, we still saw some big late-stage deals for companies like Flexport, Getir and Relex.

Our latest research on the vertical unpacks the latest VC data, highlights a few select companies, and identifies emerging opportunities in warehousing tech and supply chain tech in the developing world:
download a free preview
Webinars & Events  
This week, senior analysts across our team discussed the broader macroeconomic backdrop, how it has influenced the recent volatility and sell-off in public equity markets, and what it means for PE & VC.

We discussed it all, from monetary tightening to rising borrowing costs to VC's liquidity crunch. Watch the free replay here.

Our VC analysts also hosted a webinar dedicated to our venture valuations data and what we're seeing in how deal terms are changing. Watch it here.
  • June 22: We'll dive into how AI, IoT and information security startups are capitalizing on innovation in database technology to propel their growth. Register here.
Senior tech analyst Brendan Burke weighs in on Arduino's $32 million Series B round led by Robert Bosch Venture Capital:

"This deal demonstrates the strategic value of programmable single-board computers to the future of IoT hardware.

"Since its inception in 2005, Arduino has developed a global community of IoT programmers with its consumer-facing open-source developer kit for programmable microcontrollers.

"The company's boards combine all the peripherals for sensing and communication at a minimal cost and form factor.

"Arduino has already partnered with investors Bosch and Arm on an AI-enabled microcontroller that senses gas, pressure, location, and motion and can be programmed for specific use cases with Arduino's software.

"The global acceptance of Arduino’s software enables this partnership to compete for developer mindshare with Nvidia and Texas Instruments, among others, in the single-board microcontroller ecosystem.

"We estimate that the AI microcontroller market will grow to $4.2 billion in 2024, exceeding the scale of AI data center GPUs from 2021 and creating a market opportunity for Arduino to scale in enterprise use cases."

Brendan Burke

Senior Emerging Technology Analyst
Internet of Things/AI & ML
In the News  
Our insights and data featured in the press:
  • "Demand for growth and venture-backed businesses is non-existent," and SPAC merger valuations from months ago no longer make sense. [CNN]

  • Tiger overall invested in 361 deals in 2021, up from 16 deals for all of 2017, more than any other US manager. [WSJ]

  • The tech sector's mantra of "growth at all costs" has transformed seemingly overnight into something much more sensible. [FT]

  • Fintech valuations are falling because public markets see the companies as more "fin" than "tech," and not worth the kind of multiples software companies get. [Protocol]

  • Instacart's core grocery business is "just not a viable model long term." [Business Insider]

  • "There will be a lot of companies that will struggle to raise this year that will be easy targets for companies looking to acquire." [TechCrunch+]
If you're a journalist interested in interviewing our analysts or requesting data, contact our PR team.
Highlights from our other recent research:

Market updates Emerging Technology Research Coming next week (subject to change)
  • US PE Middle Market Report
  • Alternative Proteins Report
  • The Future of Encryption
  • ETR: Climate Tech (sneak peek!)
  • ETR: Insurtech
Thanks for reading! Feel free to email us any time with feedback, questions, or tips!

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