“I've seen the future, brother; it is murder”. The mood these days definitely has a Leonard Cohen hue to it. Who could predict the catastrophe which has befallen us over the past number of weeks? Its impact has been devastating but as with all destruction, the opportunity for renewal follows close behind.
We have enjoyed a boom in asset prices driving equities ever higher - a boon for hedge funds and private equity investors alike. Unprecedented cheap debt has induced a splurge in borrowing to fund stock buy backs and leveraged expansions across many industries and economies. While the here and now seems incomprehensible, there is good reason to hope much can be recovered. Taking action now will help ensure the asset management industry can rebound when the time comes – and there are many very attractive opportunities out there for those who seek them.
The past few weeks have found many private equity investors scrambling to shore up businesses which were, until only one or two months ago, crown jewels in their portfolios. The guillotining of huge swathes of the economy means that many businesses are facing potential ruin in the absence of rapid action both at the level of the business and the relevant Government level.
Private equity funds are responding by ensuring that the businesses they own are able to manage through the short term. The need to direct available capital to prop up these once and future stars is eating up available cash and, therefore, also reducing new deal activity (of course, the uncertainty and business disruption caused by the pandemic are no small contributors to deal slow-down too).
For those with deep enough pockets this will, hopefully, allow many of these businesses to ride out the current storm. And while some of the larger asset managers will have the wherewithal to provide this much-needed financial support, others will need help. This creates a need and an opportunity for those with available resources to get involved.
Some of the financial assistance will be directed by the hand of government with grants and subsidies and potentially even direct bailouts. Sovereign funds and State agencies are also moving to provide much needed liquidity both directly and in partnership with private industry. Whether partnering with State agencies or doing private deals, there are many opportunities for private equity and other investors to get involved.
Activity is already evident in areas such as bridging finance, sale and lease backs, and other forms of secured and unsecured financing. There is a significant opportunity to make profitable investments while at the same time ensuring the main street can re-emerge largely intact and reignite the economy.
For those with the bandwidth and fire power, there are opportunities evolving from the crisis. Businesses that have borrowed heavily over the past number of years may want to consider refinancing opportunities. Structured buy backs of extant debt will make sense for some businesses; while the opportunity to buy up cheap loan assets from lenders seeking to cash-out and focus their resources elsewhere will be an attractive proposition for some investors.
There will, inevitably, be some distressed debt sales where borrowers’ prospects have suddenly become uncertain. Risk averse investors (or those required by regulation to only hold low risk investments) will seek to exit their positions. Where such opportunities arise, the possibility of a fast recovery once the immediate economic hiatus has passed will make these potentially very attractive investments.
The general dip in asset prices will mean that there will be significant opportunities for mergers and acquisitions in the short and medium term. This may be through take-private transactions or disposals of non-core businesses as a means of raising cash. All of this has the potential to drive substantial deal activity over the coming months. Obviously, the real trick will be to differentiate between those businesses where the impact of the crisis is acute rather than chronic.
This prognostication will necessarily need to give far more weight (than has been done to heretofore) to the impact of future similar crises – whether that be an equally or more baneful second wave (as happened in 1918) or some other new pandemic festering away, waiting in the long grass. It will certainly be interesting to see how markets evolve their thinking around asset pricing in light of what has happened. It is evident that few people had factored the potential risk from a pandemic crisis into their pricing of many asset classes and did not differentiate (in a meaningful way) between those assets which would continue to operate, and in the case of certain businesses, thrive, during an emergency such as this and those which would falter from their lack of “essentialness”.
Furthermore, the impact of the great social experiment of working principally from home will have an interesting and potentially quite long tail. “Do we need all this office space and all those business trips abroad?” Likewise, will consumers re-evaluate their preferences for many of the goods and services which, hitherto, they could not imagine foregoing but which now they seem to be muddling along perfectly well without? These are questions which both prudent and intrepid investors alike will have to meditate on when trying to separate the wheat from the chaff.
Perhaps now is a good time to resurrect Dan Quayle’s aphorism "the future will be a better tomorrow." Because there is a truth to it. Yes, the short-term impacts are sharp and awesome but with the right exit strategies, governments can re-float economies to return to some semblance of normality. And there is, at last, some discussion at government levels about how we lift our economies out of this quagmire. Strait will be the gate and narrow the way, to be sure, but with forethought and fortitude it can be done.
And for those in the investment community, accurately divining the timing and the shape of the new normal that emerges presents numerous opportunities.
If you have any related questions or need further information about KPMG’s response to COVID-19, please get in touch with Gareth Bryan for assistance.