HHL survey: Portfolio companies of private equity funds perform worse than expected / Valuations under pressure

• More than half (54 percent) of PE funds have initiated restructuring and other measures
• 92 percent see a negative development in the valuations of their portfolio companies
• 57 percent of funds have injected fresh equity into their portfolio companies

"The PE fund managers were too optimistic in their assessment of the past year," says Prof Dr Bernhard Schwetzler, holder of the Chair of Financial Management and Banking at HHL Leipzig, who led this study. "However, they were in line with most economists: they expected weak economic growth in 2023, but not a contraction of the German economy. The funds' cautiously optimistic forecasts were therefore quite realistic, even if they have not materialised in many cases."

The main challenges for the portfolio companies: Rising financing costs and rising personnel costs (named by 65 percent and 75 percent of respondents respectively), pricing (60 percent), rising purchase prices and simultaneous declines in demand (55 percent each), rising energy prices (50 percent) and more restrictive lending (40 percent) as well as supply chain problems (40 percent).

"In addition to the operational challenges, the development of interest rates has also had a negative impact on the valuations of portfolio companies," says Bernhard Schwetzler. 92 percent of the PE funds surveyed stated in the survey that valuations have developed negatively due to interest rate developments, with 15 percent stating 'significantly negative'.

54 percent of PE funds have initiated restructuring and other measures - as a direct result of inflation

"As expected, the fund managers have reacted directly to the challenges of the past twelve months," says Dr Martin Schneider, private equity expert at FTI-Andersch and one of the authors of the study. 93 percent have stated that they have improved sales by optimising sales (price increases, market expansion), 79 percent have launched programmes to increase efficiency, around two thirds (64 percent) have specifically reduced production and administrative costs and actively cut staff. In net terms, the funds' portfolio companies have only added jobs in the IT department; in all other areas, there have been more job cuts than new hires.

"However, job cuts are not the main instrument for making companies more profitable again," says Martin Schneider. "It no longer works today: every employee who leaves the company today could be irretrievably lost tomorrow. The days of across-the-board redundancies are over, because the labour market is empty. And company managers are thinking ahead: they are worried about being able to continue to grow with the current staffing levels." In the survey, two thirds stated that they were worried or 'partly' worried that they would not be able to achieve their company targets and thus their valuations in the future due to the availability of suitable staff.
More than half of the companies have injected fresh equity capital
More important levers than staff cuts are in the area of liquidity optimisation: 79 percent of companies have optimised their working capital, 57 percent have injected fresh equity and half have reduced investments.

20 percent have stated that their relationship with their financiers is now 'rather tense'. The risk premiums for financing have increased for 85 percent of respondents, of which 25 percent have increased 'significantly'. Just under two thirds (60 percent) of the funds surveyed stated that financiers have signalled greater restraint in lending. 40 percent are confronted with more restrictive loan agreements.
Bernhard Schwetzler sees future challenges here: "The interest rate trend has made it more difficult for financiers and funds alike. This is why equity has played a greater role as a source of funds in recent months - and will presumably continue to do so in the current year. But the funds also need to develop a modus vivendi with the financiers that will carry them through the coming months together."

According to enquiries made to the survey participants, the tense conditions are often due to companies failing to fulfil key contractual components, so-called 'covenant breaches'. Martin Schneider says: "The banks are demanding additional analyses and key figures. However, the funds have also reacted immediately here. In our survey, just under two thirds stated that they would discuss business developments with their financiers even more frequently. Funds must now actively build and in some cases rebuild trust."

About the study:
The study 'The resilience of the private equity industry: Impact of crises on the performance of portfolio companies in 2023' was conducted in collaboration between the management consultancy FTI-Andersch and the Centre for Corporate Transactions and Private Equity (CCTPE) at HHL Leipzig Graduate School of Management.

The responses from a total of 26 PE funds based in the DACH region on the current situation of their portfolio companies were analysed. The focus was on PE funds with active portfolios of more than ten companies (73 percent). The survey was conducted anonymously and with standardised questions according to academic standards. The survey was led by Dr Martin Schneider (Managing Director) of FTI-Andersch and Prof Dr Bernhard Schwetzler, Chair of Financial Management and Banking at HHL Leipzig.