Private equity (PE) weathered the global financial crisis well and, indeed, the asset class has sparkled in recent years, delivering superior returns versus public markets in a low return environment.
Heavy competition across the sector over the last year, however, has driven deal multiples to historic highs, while growing jitters about an eventual economic downturn are affecting decision making across the sector, from diligence to exit planning.
Despite the challenging environment, the outlook for the sector remains promising, with continuing strong investor interest meaning private equity firms currently boast a record US$2trn in cash waiting to be invested.
But as private equity backed buyouts continue to surge, so does the pressure for portfolio companies to become high performers post-buyout. Private equity groups now need a faster path to positive returns – and portfolio companies need to be able to respond.
That growing pressure on PE-owned companies has led to them becoming more willing to explore alternative financing solutions. Mitch Leonard, former CFO of Electrical Components International, and Dominic Capolongo, Executive Vice President and Global Head of Funding at PrimeRevenue, point to one working capital solution, supply chain finance (SCF), as being especially supportive for portfolio companies looking to fund growth, increase efficiency and meet value creation targets.
Having experienced PE ownership first-hand whilst at ECI, a global leader in the supply of wire harnessing to home appliance and specialty industrial manufacturers, Leonard is well placed to highlight the challenges faced by portfolio companies. Value creation is “priority number one”, he says, adding: “The real challenge here is financial agility. Whether it’s deleveraging, expanding through acquisition or investing in fixed assets, companies need access to material sums of cash in order to achieve these targets. And they must meet or exceed these targets regardless of market conditions. The economic climate can vary greatly between acquisition and exit, but the PE group’s objectives are firm.”
Delivering on targets
Historically there have been a range of funding options for portfolio companies to consider including commercial lending, cost cutting and dynamic discounting. While overleveraging by many companies and the rising rate environment make commercial lending less attractive; the other options too have their drawbacks. Cost cutting is often ineffective; while dynamic discounting improves the cash position but doesn’t always deliver material improvements.
For Capolongo, the one proven alternative is SCF: “It offers a lower cost of funds than a revolving line of credit and a more material impact to cash flow.” Leonard, meanwhile, can point to direct experience of its efficacy: “During the recession of 2008, there weren’t many funding options at all for companies like ECI. SCF helped us survive much better than our competitors. Even outside of recessionary times, the value SCF brings suppliers and buyers is huge, while the multi-funder model makes sure we get the best financing rates for the business.”
As a global provider of working capital solutions, PrimeRevenue itself runs multi-funder SCF programmes. One such project involved a global caffeinated beverage manufacturer facing billions of dollars in leveraged buyout debt on its balance sheet. It turned to PrimeRevenue to pay off its debt faster. Within the first quarter of launching an SCF programme, the company generated US$750m in cash flow gain, which was used to pay back 15% of its debt and increase the trailing-12-months debt/EBITDA ratio by around 20%.
Capolongo says the uncertain economic outlook, challenging operating environment for portfolio companies, and the increasingly demanding expectations of their owners means it’s crucial PE-owned firms recognise that “it’s not just about growth – it’s about value creation and expediency”.
He adds: “Companies need access to significant sums of cash, they need it quickly and they need to do it without taking on more debt. Looking beyond traditional funding options – to things like SCF, for example – should be part of their strategy to accomplish those objectives.”