Eight private capital trends to watch

Hogan Lovells' Global Private Capital Industry Sector brings together a cross-practice team, who advise all types of private capital investors and "traditional" funds (private equity, venture capital, debt, real estate, and infrastructure), direct investors (institutional investors, sovereign wealth funds, family offices) and alternative investors. Leveraging the firm's unique global platform and in-depth industry and regulatory expertise, the group provides advice to private capital investors on their investment strategies across every asset class, industry, and geography. Below, the Hogan Lovells team provides their insight on eight key trends to watch from fundraising through investments and portfolio life, to exits.

1. Private Capital is on the Rise

"Private Capital continues to be on the rise. Traditional private equity houses have huge amounts of dry powder available. New investors have entered the global markets. While the COVID-19 pandemic has significantly reduced investment activity, for now, this will change soon. We see early signs of growing activity levels as some stimulus measures help the economies and investors focus on Q3 and Q4 2020. However, these are complex times, also for investors. In addition to traditional transactional advice, much more is needed today, especially at the intersection of business and government regulation," said Matthias Jaletzke, Global Head of Hogan Lovells' Private Equity & Funds practice and Head of the firm’s Private Capital Industry Sector.

2. Opportunities in Fundraising

"While global fundraising overall is markedly down in H1 2020, we have seen trusted managers continue to succeed and specific strategies still attract significant capital from a broad range of investors. Value-add real estate funds have been busy raising capital ready to take advantage of opportunities caused by market dislocation and many infrastructure managers are looking to create long-term yield-focused funds that also offer some liquidity to investors. Private credit is once again in the limelight as one of the few areas that (according to Preqin) has seen an uptick in fundraising overall. And in the U.S., the typically anti-cyclical SBIC program is as expected, seeing heightened fundraising activity.  Prominent themes over the coming 12-18 months will include the rise of impact investing and also the need for managers to fully embed ESG in their investment decisions - particularly in light of climate change concerns but now also needing to address the deep, adverse social consequences of the COVID-19 pandemic. As some managers inevitably find it harder to raise capital, we also expect to see sophisticated investors negotiate improved fund terms in certain key areas as a condition of committing to invest in the fund," said Nicholas Holman, co-Head of Hogan Lovells' Investment Funds team.

3. Focusing on Private Debt

"Our private credit fund clients have been spending time on reviewing their portfolio and negotiating coronavirus-related amendments and waivers where required, but what is clear is that, in contrast to the global financial crisis, there are significant volumes of undeployed capital available to support M&A activity once it kicks off again. Some private credit transactions have been completed over the lockdown period and the common theme across the markets we advise in appears to be that little has changed (at least so far) in respect of financing terms as a result of the pandemic," said Paul Mullen, a partner at Hogan Lovells.

4. Global Patterns in Real Estate

"The real estate world has been as impacted by COVID-19 as any industry sector, and we are seeing global patterns. Tenants generally are struggling to meet rents and governments have introduced a range of protective measures (see our governmental response tracker here); surveys have been impossible; valuations have been qualified; and debt has been constrained. The migration of retail from bricks and mortar to online has seen a seismic change, maybe taking it more rapidly towards a more sustainable equilibrium; and investors with a development risk appetite will be looking to reposition retail assets into other uses. Office investors will be focused on if and to what extent remote working patterns adopted during the crisis transition back to city office-based working, on whether the world moves to more flexible and/or spoke and hub models.  Logistics investors are probably pleased with their stock, but frustrated at the shortage of supply in which to invest. Hotels will be an interesting investment space, with operators struggling not just in the short term but over the long term with travel and tourism critically disrupted; and with universities preparing to teach online, student housing investors have short-term challenges too, which may present opportunity for the long-term investor. PRS/BTR/multi-family investors generally seem to be riding out the storm, with a demand for residential accommodation that is likely always to outstrip supply; the assets are a great hedge through recession, but the yields reflect that," said Daniel Norris, a partner at Hogan Lovells.

5. Private Equity Transactions to Increase in Q4

"The number of new transactions are down significantly, and work has often been focused on supporting existing portfolio companies. We would expect transactions to increase in Q4 of this year as there is more stability in the business. Notwithstanding the general downward trend, transactions are still happening, either portfolio companies in sectors particularly hit by coronavirus being sold in “pre-pack” insolvencies (e.g. retail or restaurant sector) or new platform deals in portfolio companies that are well placed in this environment (e.g. technology and/or life sciences sectors).

U.S. Bankruptcies have not increased at expected rates yet, as Companies continue to sit in holding pattern that should result in increased filings in Q3 and Q4 which will increase opportunities for funds for acquisitions. On June 11, 2020, Fitch Ratings indicated that U.S. high yield default rates were rising to 5% in June YTD driven by energy defaults. Over the past two months, default volume was US$32.7 billion. The energy trailing 12-month default rate stands at 11.1%, and could reach 14% by June 30. Fitch Ratings projects energy to finish the year at 17%. Elsewhere, Europe is seeing a significant step up in stressed finance work, with sustained pressure on businesses now forcing to the table those which have managed to survive thus far. Whilst formal lock down restrictions are easing, business is a long way from pre-COVID levels and furlough programs are running off. We are seeing a lot of companies having to renegotiate their financing package and/or raise new capital in this period, and in some cases there will be failures. This is creating finance opportunities, and buyside opportunities, for agile funds. We expect this trend to accelerate through Q3 and Q4.

Regulatory hurdles are also increasing throughout the globe as various jurisdictions have begun to focus on increased regulations on investments as various countries like EU, UK, U.S., AU and others focus on supply chains disruptions identified as a result of COVID or national security issues," said Robert Welp, head of the firm’s Private Equity & Funds practice for the Americas.

[See UK Merger control: Public health emergencies and foreign takeover scrutiny; U.S. Treasury Department issues final CFIUS regulations; Foreign Investment in Australia’s Energy and Resources Sector].

6. Seizing Distressed opportunities

"We are at the front end of a significant period of companies in need of a meaningful debt — and in many cases also an operational — restructuring given the pandemic and the permanent changes it appears to have accelerated. What was being called the “retail apocalypse” even before the pandemic has now really started to play out, with major filings across the board in the world of brick and mortar retail. We’ve also seen the continuation of historically low oil and gas prices, and accordingly the number of Chapter 11 filings in that industry continue to rise. And those were just the businesses in trouble before even factoring in the effects of COVID-19, which has seen significant impact in the travel industry, with several Latin American Airlines having filed for Chapter 11 already, and with others possible needing to do the same or follow the path of the U.S. airlines and borrow major amounts of capital, which will impact on their profitability for years to come. Yet, at the same time, the government is doing everything it can to prop up the economy and providing a debt safety net. Moreover, the high yield markets have been wide open, providing a safety net for struggling companies (among others, the cruise ship industry). And private equity is loaded up with cash and protecting its investments through additional debt and capital infusions. But how long until the safety net wears thin? We could be headed for a major wave of restructurings, and those with distressed experience and capital to put to work, will be in for major opportunities that will reshape the economy," said Chris Donoho, Global Head of the firm's Business Restructuring and Insolvency practice group.

7. Extremes in Venture Capital

"We are seeing two extremes in venture capital investment activity, particularly in the tech sector. On the one hand, investments in late stage tech companies that have a market or product niche are continuing at a record pace, at high valuations and on company-friendly terms. The competition for these investment opportunities remain fierce among strategics and financial investors and COVID-19 has accelerated the intensity and duration of these deals, getting across the finish line at a break neck pace. On the other hand, companies that were underperforming or were being considered for potential sale opportunities are facing headwinds and investors are considering the full range of options from exiting in a distressed M&A scenario to bridging financing to cost cut measures to weather the next few months. There does not seem to be much in the middle between these extremes. We are seeing subsectors like healthtech, cleantech and similar tech enabling end user consumer convenience seeing a lift due to COVID-19 providing not only business opportunities, but proving the business thesis of these innovative companies," said Mahvesh Qureshi, a partner at Hogan Lovells.

8. No Exits

"All typical exit routes for Private Capital participants have been adversely impacted by the COVID-19 pandemic. Overall M&A is down by 53% and IPOs are down by 19% YoY, the two main exit routes. Asset prices are overall depressed and uncertain- potential sellers and buyers may want greater certainty about valuation and economic prospects before transacting. Conducting due diligence exercises involves physical meetings and travel, something which is complicated right now. A lot of market participants will have been, and may remain, preoccupied by other draws on their time and resources (see above Private Equity). There are some sectors that investors of all type will be wary about investing in, which will cut off exit opportunities. However, there are still deals happening (such as Facebook's US$5.7 billion investment for a 9.99% stake in Jio Platforms, as well as Intel's US$900M acquisition of Moovit), particularly in sectors such as life sciences, tech and infrastructure. There are also other drivers- there are historic levels of 'dry powder' in PE funds, debt funds and secondaries funds which can be deployed for transactions (Preqin estimate US$2.44 trillion), there are Private Capital participants that will need to rebalance their portfolio of investments and some of that may become forced sellers. Interest rates are for the moment at historic lows and investors will need yield. Overall, there are drivers to indicate that exits will pick up in Q4 and 2021, although the level of activity will be impacted by how the next phase of the COVID-19 pandemic plays out. Alternative exit routes may also become more widely used by Private Capital participants, such as releasing liquidity through use of preferred equity or strip sales and, for Private Equity, implementing GP led transactions (whereby a fund sells assets to a related fund, with existing investors being able to rollover or cash out, with new investors underwriting the cash out)," said Ed Harris, a partner at Hogan Lovells.

More about Hogan Lovells Private Capital practice can be found on the Hogan Lovells website here.

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