Dry powder: time for an explosive growth in private equity activity?

Monday 30th March 2020

Private equity funds are a type of private investment fund. Generally speaking, they pool cash from investors which they then invest in businesses in exchange for an equity stake in said businesses – hence the name private equity. This is done with a view to eventually selling that business for a profit, perhaps having restructured it operationally and/or financially during the period of ownership.

It has long been documented in the business press how successful private equity funds have been in generating historical returns for investors – almost consistently outperforming pension funds and most indices of public markets such as the US S&P 500 or UK FTSE 100.

‘Dry powder’ is the term often applied to the (substantial) reserves of cash that private equity funds hold. At the start of 2020, data from Prequin indicated that the private equity industry was holding over $2 trillion of dry powder from investor commitments that had not yet been deployed. This figure covers funds from a variety of asset classes that can be grouped under the private equity umbrella – including funds focusing on buyouts, growth capital, real estate, infrastructure and private debt. Dry powder is often seen as a reserve held by funds for emergencies or, perhaps more accurately, opportunities for investments at a time when the valuations of targets are favourable to the buyer.

It seems the present economic situation, in no small part due to the situation around COVID-19 globally, may be presenting such an opportunity. Indeed, in the UK recently, a number of notable private equity deals have been executed. Already this year, Blackstone bought a portfolio of 22 industrials and logistics assets from Clearbell Capital for £120m. This came in the midst of COVID-19, with an expected increase in consumer demand for online shopping and delivery services as a result of the crisis. Also this month, KKR purchased Viridor – the waste management business of FTSE 250 utility company Pennon – for £4.2bn. Turning to Europe, just earlier this year, a consortium including private equity funds Advent International and Cinven acquired the elevator technology business of German industrial conglomerate thyssenkrupp for $17.2bn in the largest European buyout transaction since the global financial crisis of 2008.

It should be borne in mind, of course, that many of these large transactions would have been ‘in the works’ for months. Nevertheless, their closing at a time when the world is responding to the coronavirus crisis highlights the inherent ability of private equity to find and complete deals whenever the economic situation presents opportunities. Reserves of dry powder are, naturally, crucial to the funds being able to make use of such opportunities at times like this. Additionally, it can be expected that many businesses’ valuations will be softened at this time – giving rise to potentially even more private equity investment opportunities.

As with any developing crisis, the full economic impacts are yet to be seen – though it remains clear that private equity is well-positioned to respond effectively and should be able to execute transactions that will help maintain the industry’s historically above-average returns.

On the note of a crisis, many private equity funds have a wealth of knowledge and ‘lessons learned’ from the last financial crisis. The importance of being active in acquisitions and sales of assets when crisis strikes is great. Interestingly, recent research from consultancy firm McKinsey & Company “shows that public companies that outperformed coming out of the last recession divested underperforming businesses faster than others did and made acquisitions earlier in the recovery phase.”

Private equity’s level of success in navigating this crisis will doubtless be discussed in the years ahead, but of course, as the cliché goes, ‘hindsight is 20/20’. What can be said now though, is that private equity is certainly being active in its response to the current economic situation.