Private Equity on the Upswing: Marking Revival in Q2 2024

[00:00:00] Sean Mooney: Welcome to the Karma School of Business, a podcast about the private equity industry, business best practices, and real time trends. I'm Sean Mooney, Luwe's founder and CEO. In this episode, we have an encouraging discussion about what happened during Q2 2024 in the world of private equity, why it happened, and how this informs what will happen in the days ahead.
Enjoy.
Today, we have a special episode where we're going to go through the headlines of BluWave's Q2 2024 Private Equity Insights Report. The headline is a good one. In this kind of washing machine world that we live in with good news, bad news, good news, bad news, I'm really excited today to talk about some good news.
Here's the headline. The deal market, as we predicted in the second half of last year, is now starting to recover in line with the overall strengthening and robustness of the economy, which little by little is also getting a little bit better every day. So really good news to see this economic engine of the world, the M& A market is starting to wake up.
As I think about this particular instance, the way I think about the world right now and the economy and the deal market is kind of the way that I felt going through the change of seasons. in my newish found home of Nashville. So I've lived here now since 2016. So it's almost eight years. So it's not so new anymore, but it's still like getting used to it after living in the northeast for more than 20 years where it just get cold and it felt tough.
And that's how I felt a traditional economic cycle was you go through winter and it's frigid. Well, the one we've been going through is kind of like here in Nashville where in December and January, it's pretty cold. It'll get below freezing. You get a little bit of snow. But then, it only lasts for a few days or a week, and then you get a 60 degree day to kind of warm you up, and your faith and your hope is restored, and you kind of look forward again, like, oh, we'll get through this.
And so, really, as I think about now, we've been going through this December and January over the last couple years of, in the Nashville version of it anyways, where it's cold, not too bad, but it's still rainy. And then you start moving into, like, a January and February, maybe even early March, where it starts warming up, but it's still kind of gray, and you get walloped by these storms that come across the plains every week, so you're still thinking, you know, I don't know that things are getting better.
And then, suddenly, late March and early April comes, and you start noticing more nice days than rough days. And next thing you know, a beautiful spring arrives. So right now, to take this metaphor further, I feel like we're in that kind of like, early March phase where it's starting to get warmer and starting to get nicer, but I still have my set of eyes pegged on weather.
com because I see this storm coming through and I still haven't taken my winter coat off the hook in my closet and packed it away yet because I just don't believe yet. But little by little it's getting warmer and nicer and warmer and nicer and next thing you know spring will be here. So I feel like and the data shows that we're in this kind of early, maybe even mid March, where you can feel it and see it coming, but you don't quite believe it fully yet.
So let's get into why we think we're in mid, maybe even late March in Nashville. And so there's a number of factors that we look at, including external data, internal data, as well as just kind of synthesizing all of the information that we get from the best business builders in the world in PE and how they're acting.
And so we think the deal market's improving. We believe it's improving because the economy continues to be good enough and is getting little by little better. We also know that the limited partners who are really the bosses in the private equity industry, those large endowments, pension funds. High net worth family offices that invest in private equity firms.
They are meaningfully influencing and some might say pressuring private equity to sell their companies. And we'll get into that and why. So there's a lot of influence to almost will the market to come back. And then lastly, we're objectively seeing PE firms taking action and both the selling and buying of companies in ways they haven't done in a long time.
And so. Let's break that down. If we first talk about the economy being good enough, and getting better, the first thing that I look at every single, in some ways quarter for sure, but definitely monthly, any time a measure comes out is inflation. And so if you look at the peak inflation not too long ago in 2022, it topped out at 9.
1%. Well, the most recent measure that came out in June 2024 is 3%. That is a huge drop in a very important drop because until you get inflation under control, there's not a lot that you can do otherwise, or you risk a back to the future return to the 80s. And so that's a really important measure. And where we're getting down to at 3%, if you look at kind of the historical data, that's actually getting us to kind of where we were in 2018.
We're actually at 2. 9 percent inflation in June of 2018. And we've kind of bumped around historically between two and three. And let's not lose perspective, by the way, that that 2 percent measure is something that was discerned or created by. a then obscure central banker in New Zealand who decided that the measure should be 2%.
And so everyone said, okay, it's 2%. But historically, two to 3 percent has been kind of a positive area to be in. And we're right at the cusp of that. And so what happens now that we're getting into that three going into twos, is it's opening the door for the Federal Reserve to start doing something about reintroducing stimulus, lowering interest rates, which has ripple effects across the rest of the economy, including the deal market.
And so, getting that under control will be important, but we're in the range, we're kind of entering into the discussion of let's go. The other thing that we've seen is that GDP continues to sufficiently grow in a good not great way. And as I look at the data, if you go back into the first half of 2022, we actually had two negative quarters of GDP, which is the traditional measure for a recession.
Now, there's more to it than just that. But that's typically when people would say we are in a recession. And that also doesn't factor into kind of a mini COVID recession. So here we may have almost had a double dip already. The one thing I do know, after having way too many recessions under my belt, and I'd care to admit, is that the Federal Reserve, those who are in charge of monetary policy, the Treasury, the SEC.
No one is going to say we're in a recession while we're in a recession because it would just make the recession worse. And so what I think will ultimately happen as we've been in this kind of washing machine, is at some point someone's going to say, yeah, by the way, 2022 we're actually in a recession, we just didn't want to say it.
And so, They're going to come back, and what I think is really important is we've managed not to kind of triple dip into another recession, much to the credit of the way that the Federal Reserve has managed this. Now you can certainly talk about their job getting us into the inflationary push before all this happened, but since then I think they've done a pretty good job.
And so we're kind of coming in, we've got positive GDP, it's bumbling around, it's good enough. The last big measure that we're looking at as part of this report to say, okay, do we have the preconditions in place to pull the nose up? It's really looking at unemployment. And if I look at unemployment, Over the last several years, one of the things that is almost counterintuitive is that unemployment was too good.
And so if you think about a well behaving financial and economic system, you actually want to have a certain amount of unemployment because it keeps the job markets from overheating, it keeps the labor markets from being very inflationary. And so, if you were to go back in time, and not too long ago, in April 2023, unemployment was 3.
4%. That was, I think, the lowest since May of 1969. The labor markets were overheated. And what the Fed's been trying to create, and trying to get accomplished is, still have a good employment market, where people Might lose her job, but then go back and get a brand new one. But not something where everyone's lining up and fighting for jobs, is they've actually been increasing it.
And so the good news is, in June of 2024, unemployment went up to 4. 1%. And that, in our mind, is a good measure. The job markets aren't overheated, but they're healthy enough such that if someone does lose her job, they can go get a new one. And so, There's a lot of good measures here that say, you know, an employee is good enough and actually getting better.
Now, there's still all sorts of things that could derail this, but right now, current course and projection, the economy is good enough and getting better. The next thing that we're really looking at in terms of the resurgence of the M& A market, the deal market, is Looking at how limited partners, the bosses of the private equity firms, are influencing the private equity industry to start selling their companies.
And one thing that's really important to understand is that limited partners require money being sent back to them on a regular cadence in order for them to make commitments reciprocally to private equity firms, venture capital firms, those that require money and can't send it back day to day like a public market.
And so the LPs are looking at and saying, Hey, if we look at the distributions that you're sending back to us as a percentage of the net asset values that you have under management, we are reaching near all time lows. And so why is that? Well, private equity firms are saying we only get to sell these companies once the deal markets have been kind of frozen.
It's not a great time to sell. So we're just going to wait it out. And so we're going to wait it and wait it and wait. And then when, when we see everything good and we can kind of get what we think is a fair price, we'll sell it because they make a lot of their money on a percentage of the economics of a sale of a portfolio company, so long as they beat the long term average of the U S stock market.
And so the LPs are saying, listen, private equity. And if I look at the pitch book data, they're saying, Typically, you're sending us back about 30 percent of the amount that you have under management in any given year, plus or minus, if we look at the last 12 months, it's less than 10%. So if you want us to recommit to your next funds, you better send us some money back.
And so there is a huge amount of pressure being exerted by the limited partners who saying you want us to commit to your next funds and we want to commit to your next funds because you're outperforming everyone else. You have to send us money back. And so the PE firms who rationally individually were saying, well, we're going to wait it out.
So, cause we only get to tell these companies once now they are being heavily influenced to send money back. And so for those of you in the private equity world, you'll understand this term called DPI distributed to paid in capital ratio. And what they're saying is. To the extent that you've called capital, how much have you actually sent money back as well?
And so it's a very simple measure. Before it was always, what's your internal rate of return over an X year period of time? What's your compounded annual return? Now it's what's DPI and what's your IRR? So there's a lot of influence by the people who are the bosses of the private equity industry to send money back.
And you do that by selling companies. And so that influence has to have an impact because you got to listen to your boss. That growing drum beat is reaching a fever pitch within PE and we're starting to see, as we'll talk about in a moment. PE firms starting to sell
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[00:12:31] Sean Mooney: The next thing that we're seeing is PE firms starting to sell and how do we know that? One, we're looking at deal flow year over year, and as we talk about real time measures, those that are actually happening within PE, that will only be revealed probably months from now. The contacts in our network are saying that deal flow is getting better and better, and we have some of these measures in our quarterly insight deck that you can request and see.
They're showing that their deal flow is not tidal wave better, but it continues to improve. And particularly in the first quarter, in April and May it improved, then it softened a little bit in June, but now it's strengthening again. And so our PE firm customers are telling us that deal flow is getting better.
And there's always kind of a difference between firm to firm because they have different levels of standards, et cetera. They have different strategies, different sets of the market they target. So it's hard to get a really concise measure on that, but net net, it's getting better than worse. But then if we look at really tangibly what we see as leading indicators in terms of what is it really getting better as we looked at our internal data regarding projects for due diligence to spend money to buy a company in the end of the second quarter 2024.
So June 30th, 2024 versus the second quarter last year, we've seen a 39. 1 percent increase in due diligence project requests. That's a massive increase and it's a very predictable and I think strong measure because we only get calls when the private equity firms are willing and compelled to spend meaningful money to assess a company in anticipation of buying it.
Private equity firms aren't going to spend the money if they don't think the companies are worth it or the conditions aren't right. So when we actually see our measures growing at that rate because they're willing to do big expensive projects in support of buying a company. That means something and it should to everyone else.
So we're seeing very strong, important measures about the PE world getting ready to take action. The other thing that we're seeing is a lot of activity around previously out of favor sectors. And so within this PE world that we support by connecting them with these kind of amazing private equity grade resources that they need, we've seen a 72 percent quarter over quarter increase in manufacturing related companies.
very much. And a 46 percent related quarter over quarter, year over year increase in software. Both of those sectors were highly out of favor. So that's another measure that shows some of the sectors that previously most people would say were in kind of a recession. They're coming out of it because PE firms are betting with their dollars and they're investing in these companies.
And so that's a really, really important measure as well that I think everyone should not lose sight of. Net net, just to recap, we're seeing that the deal market is recovering because the economy is good enough because the LPs are exerting influence to make it happen. And then at the same time, We're actually seeing in our data that PE firms are doing so, and we're seeing it before it will really flow through to the rest of the market.
The other thing that I would just weigh in as you think about is the deal market coming back. Let's just not lose sight of kind of the basics, the first principles. Part of the reason this market is coming back is because it has to. There's way too much power, influence, money at stake for it not to. And so if you think about this, the investment banking industry needs to pay itself.
The limit partners have to deploy capital. The direct lenders who have raised billions of dollars of capital over the last year have to deploy it. And that's another thing that's really happening right now is the debt markets are so much stronger than they have been in the last couple of years, and they're getting more and more competitive.
So they're predictable, which is a precursor to being able to do a deal. And then lastly. PE firms, their business is deploying capital and building them and selling capital and PE firms have to buy and sell. Every part of the industry has to get this gear going again. And what are we seeing? We're seeing the gear spinning.
It's not spinning out of control. It's not a tidal wave, but it will continue to get better in the same way that in December, it's pretty cold, but not so bad in Nashville. And then February, March, it's getting better. Pretty soon April is going to be here and you're going to see lots of kind of flowers and things like that.
There's all sorts of stuff that could go wrong, so let's not lose sight of that. As you look at our report, we spell those out. You've got to be mindful that there's a lot of geopolitics going on right now. There's a lot of kind of scare in the world that we're all well aware of. That's not part of this show here, but we all know what it is, and it's tragic and sad in many ways.
Oil and gas is still pretty volatile. You've got the U. S. consumer, the commercial real estate industry. So there's a number of things that could kind of cause trouble here. But net net, we're finding a way and the green shoots are pushing through and they're growing faster and faster and the sun is coming out and the days are getting warmer.
And so let's take this moment to say, you know what, this feels good and I'm getting to be excited and we can all run towards opportunity. That is a high level of what we're seeing in the Q2 2024 Insights Report. There's all sorts of other nuggets in there. A number of them will be kind of beta that will give you confidence that what you're seeing is what others are seeing.
But there's also a lot of pieces of alpha that are going to give you edge to play the field and play the game with a little more information, insight, and edge and make you more successful in the days ahead. If you'd like to get a report, you can contact your client coverage representative at BluWave.
You can request one on our website. You can give me an email. So, we really, really appreciate everyone engaging and willing this market to move forward. And at least I feel really good about better days ahead.
That's all we have for now. Hopefully this has been helpful in terms of instructing what we're seeing, what the best business builders in the world are doing, and some things that you can actually add to your toolbox to do the same. Special thanks to our listeners for joining today. Please continue to look for us anywhere you find your favorite podcasts.
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Private equity insights for and with top business builders, including investors, operators, executives and industry thought leaders. The Karma School of Business Podcast goes behind the scenes of PE, talking about business best practices and real-time industry trends. You'll learn from leading professionals and visionary business executives who will help you take action and enhance your life, whether you’re at a PE firm, a portco or a private or public company.

BluWave Founder & CEO Sean Mooney hosts the Private Equity Karma School of Business Podcast. BluWave is the business builders’ network for private equity grade due diligence and value creation needs.