Private Equity is Throttling Toward a Breakout: Q3 2024 Insights

[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, BluWave's Founder and CEO. In this episode, we have a really insightful conversation where we're going to pull back the curtain on what the best business builders in the world are doing This should hopefully also give you a lot of ideas on how you can create extra value in your own companies. Enjoy.

[00:00:37] Welcome to our quarterly report update session where we're going to discuss the trends set forth in BluWave's latest Q3 2024 PE insights report. During this episode and in this report that we just released is discerned through the lens of project activity with many hundreds of private equity firms, thousands of portfolio companies.

[00:00:59] We discuss what the best business builders in the world are doing, how they're doing it, and why they're doing it. The PE firms we work with are about as proactive as you can get, because they have to be in order to be successful, generate returns. The competitive tension in private equity is so acute these days.

[00:01:19] If they're not doing things in a way that's different, that's creating alpha, they're not going to be successful. So for our listeners, this podcast episode, the quarterly report is an excellent source of crowdsourcing for ideas for you to replicate in your own PE firms, portfolio companies, operating companies, public companies, et cetera.

[00:01:41] Do as they do. Don't recreate the wheel. They're operating in this incredibly competitive environment that forces them to see forward and future and see how. The world is going to be and then bend space and time to their own will versus reacting to it. So this is a great source of ideation for each of your own companies.

[00:01:58] So as we looked at the data in the third quarter of 2024, ending September 30th, we saw a number of things. Here's the headline though, PE firms are throttling down, but they're not getting as much traction as soon, as fast as they prefer. Things though are setting up for a breakout in 2025, and those that are taking action earlier are going to abnormally benefit when we enter into the next five, six, seven year growth cycle that appears to be on the way, you know, save some catastrophic.

[00:02:36] Black swan that we don't see yet. So let's break it down and how the data is really telling us this is what's happening when we look at things through the lens of the private equity world and the projects that are coming in, we see a number of things. First, the deal market is improving slowly. And surely, but not as fast as many would prefer.

[00:03:02] There are some reasons why, and we'll get into that. Second, P firms are holding onto their core teams more so than they have because they've already shifted their team mix in large part towards growth oriented leaders away from the wartime generals that were brought in through the COVID era and through some of the many recessions that have occurred in some of the parts of the economy, like industrial.

[00:03:26] And they're holding on more so to these teams because they're seeing what's coming ahead and they've already made a lot of top grading changes. Third, PE firms are taking massive amounts of action with initiatives related to growth. So we'll break down each of these in a moment here and tell you a little bit more about each of those and how it kind of sets things up for what's likely going to be a really good 2025 private equity.

[00:03:51] The first area we talked about was the deal market improving. But kind of in a good, not great way. When we look at our data, when we look at our client's data in terms of what they're seeing in deal flow, it's getting better, but the challenge is, is just not that much better. And what we see when we look at the projects that come in.

[00:04:14] A lot of them get started and then they stop. They don't close. The deals don't proceed. Now, a lot more are still happening than have been going in previous periods, but it's still kind of like this grind that's going on and then people are folding their cards more so than anyone would prefer. And the reason for that is there's still a big bid ask spread out there.

[00:04:35] You've got sellers who want top dollars. They remember 2021 or they need top dollar. To generate the returns they need to send back to their limited partners. And then you have buyers who are looking at an environment that's still kind of good, not great. And they're saying, well, I'm not going to pay top dollar yet.

[00:04:52] And so. What that means is the deal market is kind of improving, but it's still kind of slow and still kind of ground down. The second thing that we spelled out in the beginning of this episode that's happening right now is that private equity firms are largely holding on to their portfolio company teams right now.

[00:05:09] Now, they're still doing a lot, but just not nearly enough. And so one of the things that kind of, like, shocked us, When we looked at our data, and we saw that within overall activity, human capital in the third quarter of 2023. Represented 49 percent of all the projects that came into BluWave, that's a staggering amount.

[00:05:31] That's as high as it's ever been. Now, when we looked at what happened right now in the Q3 of 2024, it was 38%. That's a huge drop. And then when, but then we looked at it, like, well, how to compare to 2022, it was actually higher than 2022. So 36 percent of Q3 2022 projects were human capital. So they're still doing a lot, but we're just not seeing the frenzy that occurred in 2023 when we further break down the data, because we're just looking like this is not what I would have expected coming into this, particularly with the people centricity that's going on in private equity today.

[00:06:08] It told a slightly different story. And so we still see a lot of activity right now as it relates to CEOs and non executive search. And it's not as high as it was in 2023, but much higher actually than it was in 2022. And so people are still making changes at the top. Times are difficult, times are challenging.

[00:06:31] They got to get the right leaders in place. They're making changes in kind of the non executive spaces. They're adding lots of people to equip their strategies. But what we saw was non CEO C suite searches and interim executive requests. We're actually pretty meaningfully down versus both 2023 and 2022.

[00:06:53] So what that tells us is one, private equity has taken a lot of action already to kind of top grade and reposition their teams for the growth market that they were hiring for last year. They were expecting a little more so this year than has occurred. But I think what we're seeing is they think these folks are still ready for the next period.

[00:07:11] They're ready for 2025 because that's who they hired for. They hired for this breakout period. The other thing that I think is driving this is the cooling of the labor markets. One of the things that's really counterintuitive to many is when the labor market was in the threes percent unemployment, the lowest in decades.

[00:07:30] That's actually really not great for the economy. It's one of the biggest sources of inflation we're dealing with. People were job hopping. They were poaching. Everyone's getting dollared up having to give massive raises to deal with all the inflation that was going on. Well, what else that means is you're losing a lot of your team members.

[00:07:46] So for the first time in a long time last year, we were seeing P firms losing C suite people before they sold the company, before the options became recognized and invalidated and. Turned into cash. That's not very typical in P. E. And so, but we're actually seeing a lot of people leaving. So I think with the cooling of the labor market.

[00:08:04] Getting into the force, which is really most accounts will tell you want to be in that 4 to 5 percent range of unemployment. We're actually at a healthier level of unemployment. with a higher level of unemployment. And so I think that's part of what's kind of settled down some of that mid level hiring is because people aren't getting cherry picked left and right.

[00:08:21] That's another thing that we look at is like, okay, they're hanging on to their teams. They've already made big changes. They're still doing a lot. They're still top grading, but just not as much as during some of the frantic periods of prior years. And then the third thing that we looked at when we looked at the data is they're investing heavily, heavily in growth.

[00:08:39] As set forth in the BluWave insights deck for the third quarter. One of the things that jumped out that was really striking when we looked at our value creation activity index, growth strategy activity was up 80 percent year over year. So Q3 2024 growth strategy activity Was up 80 percent more than Q3 2023.

[00:09:03] That's a huge amount. The other thing that we saw was sales and marketing effectiveness activity was up 20 percent year over year. And so the PE firms are willing their companies to grow and they're trying to get a head start in advance of the economy more naturally kind of revving up in the days ahead.

[00:09:24] And so what all this leads us to believe. is that the year's been a good one, not necessarily a great one, but people are seeing kind of like through the haze, they're seeing the blue skies ahead and they're doing things to get an early start so that when the clouds totally part and they can see the blue sky, their vehicles are going at top speed.

[00:09:48] And so as you'll see in the deck and for people who listen to these podcasts, you probably know by now that I love to speak metaphorically. I grew up in Texas. It's the only way they taught us how to speak. It is what it is. But the metaphor that I got in mind is like having a convertible or like a Jeep Wrangler.

[00:10:07] It's been in your garage all winter long and you're ready. Like, when's it going to get nice? I'm tired in the winter. I want to just get out and drive with wind in my hair and be happy and whatnot. And so you pull out the car at the really kind of the edge of winter. And then you put your key into it.

[00:10:28] This is kind of what it was like earlier this year. You're ready to go. You turn the ignition. And it goes vroom, vroom, vroom. And it just wouldn't start. And you go, oh, I thought we were there. I was ready to hit the gas and like drive the Jeep Wrangler out and around town. And it's just not going to start.

[00:10:46] So you go and you get in there and you find your trickle charger. And you gotta wait, and you let the thing trickle charge, it's getting going, it's starting to get better, and then suddenly you're like, alright, now the thing is good to go. But it's still kind of that, like, late winter, early spring, you get in the car, you pull it out of the garage, you lower the top, you hit the gas, and your driveway's wet, and the tires are spinning a little bit, but you're starting to go forward, and you're starting to get sighted.

[00:11:15] So, that's kind of like, I feel like, right now, as the industry is. It's like. We're off and going, the battery's charged, we're ready to go, there's gas in the tank, or at least enough to get going, and now the tires are spinning a little bit. But you're starting to gain traction, you're starting to get down the road, and you're getting ready to turn the music on and buckle up because you know Convertible weather is here to come.

[00:11:36] That's kind of where I think we are right now in the private equity industry and the economy at large for that matter. And so what they're doing is maybe a reflection of some of this topsy turviness, but they're kind of willing their way into the future and they're doing things that foretell and foreshadow kind of rosier times ahead.

[00:11:57] The other thing that kind of foundationally supports this Is once again looking at the macroeconomic fundamentals, right? And so we've got inflation coming way down. You've got the consumer price index, I think from September, 2022, going from 8.2% to 2.4% in September, 2024. You've got nine consecutive quarters of GDP growth with the most recent one in the Q2 printing at 3%.

[00:12:28] You've got the Federal Reserve now introducing stimulus. They did the 50 bit reduction and they're going to do more. And then lastly, particularly as it relates strictly to private equity, they received a ton of stimulus just from the competition in their own capital markets. So the direct lenders raised tons of money last year.

[00:12:49] Because they were doing quite well. In the beginning of the year, if you talk to friends of ours and network of ours, they could borrow at SOFR, which is essentially the rate that banks will lend to each other, plus 700 to 800 basis points, plus 78%. Now, they're lending in SOFR starting in the three, so 300 to 400.

[00:13:13] So that's a huge reduction in interest rates. It's a huge reduction in the amount that they have to pay an interest expense for the debt that they borrow to buy a company. So think about your mortgage rates coming down by three or 400 basis points or three or four full percentage points. So what does that mean for this bid ask spread that we've talked about?

[00:13:35] What that means is if they're spending less on interest, they can borrow more debt. They have to put in less equity. Just like if you think about on your house, right? A lot of people buy houses and pay for houses based upon what they can afford after they pay their mortgage principal and interest. If that goes down, they can buy more house the same way private equity firms with their interest expense going down and about amount that they can borrow can go up.

[00:13:57] That means they can pay more for a company, which means the bid ask spread is going to decrease, which means buyers are going to be able to meet sellers expectations, which means the whole stuck kind of ecosystem of the M& A market will continue to ease with every month. And then, you know, last and certainly not least, As soon as we get this election angst off of our shoulders here, from a behavioral economics perspective, it's just one less thing to worry about.

[00:14:25] We know who the president is, and this is irrespective of which party you'd like, there is a behavioral economic benefit to just having this thing over. And I think that psychological benefit in line with also The Federal Reserve saying help is on the way by bringing you more stimulus with each review period.

[00:14:45] That just lets everyone know everything is okay, everything will be okay, and it's time to get going with life. There's just too much money at stake for this ecosystem to not get revving again. And we're quite confident that we're seeing the engines running. The tires are spinning a little bit, but they're gaining traction.

[00:15:04] And then this whole ecosystem should be approaching full speed next year.

[00:15:10] Commercial: Today's episode is brought to you by BluWave. Building a business is hard. Top third parties can help you create value with speed. Speed and certainty, but it's difficult to know who's best. That's why you need the business builders network.

[00:15:22] Visit BluWave at B L U W A V E. net to learn more and start a project today.

[00:15:31] Sean Mooney: So this is a good time to check in on the predictions that we made. in the fourth quarter of 2023. For Q2023, we made essentially five predictions. One, that we said that the economic rebound was going to start. We were going to go through kind of the bottom of this J curve, then there's going to be stimulus introduced, the world was going to start waking up, and we're going to enter a new six to eight year Growth cycle that is in tune with a normal economic cycle, not one of these 15 year mega cycles that we went through after 2008, 2009.

[00:16:04] That I think we're pretty much on track if we look at it. All systems seem to be showing that a soft landing has occurred. We're fueling up the vehicle now and we're ready to go into the next horizon. I think we feel pretty good about that. We thought that PE firms were going to start selling again. I think we're a little behind on that.

[00:16:24] The PE firms have not been selling as much as we thought they would be. It's inevitable that they will. As we looked in January of 2024, the median age of PE Porcos was a nine year high and distributions as a percentage of 13 year low. That logjam, that kind of stacked aging of portfolio companies has to start getting returned because private equity firms are in the business of raising capital, intelligently investing it, and returning capital, and the industry hasn't been returning as much capital as they have historically.

[00:16:58] And so if they want to raise new capital, they got to send it back to the LPs. So the circle of life can begin again. So that's a matter of when, not if we think that's going to continue to accelerate, particularly as the preconditions emerged that enabled the bid ask spreads to narrow and the PE firms grow into the numbers that they need, which is another reason why they're investing so heavily in growth.

[00:17:20] They're not going to just wait for fate to catch up. They're going to bend fate and space and time into their will so that they can make things happen that need to happen. And so we think that's going to continue to start getting unstuck as the months occur here. The other thing that we said is now's the time to buy the bottom and hit the gas.

[00:17:40] Today, I still think this, and I think we're very confident. The deals that have been done in 2023 and 2024 are going to be the best vintage deals of this whole kind of cycle here. That is true in almost every economic cycle. You can look at the Hamilton Lane data. You can look at a whole variety of sources that will show that people that buy in the bottom of these.

[00:18:02] Cycles, the beginning into the next row cycles will benefit differentially. We think the P firms, the M and a participants who are buying now are going to do really well over the next three to five years when they exit this crop of deals that are being done. The other thing that I think we were pretty on track on is that the P firm ecosystem, business builders, et cetera.

[00:18:24] Yeah. Yeah. Are going to realize that the pie in the sky buzz associated with AI is really a tactic, not a strategy into itself. And so we thought that it felt a lot like kind of 1995 over the last couple of years with all of this buzz similar to like when the Internet came out, when Netscape was introduced, suddenly mere mortals could use the Internet.

[00:18:45] You didn't need to be like a coder to use it. It's the same thing with these LLMs. Everyone's like, Oh, that's great. You know, but large part is kind of like an interesting, I don't know if toys the right word at the very beginning, but it was kind of an interesting sideshow. I can find answers to questions more quickly.

[00:19:00] Well, now what's happening is all these capabilities are getting embedded into application specific use cases that are in service to a larger strategy. And so that's a really important distinction versus 2023 in the beginning of that year. It's like, it's going to cure all of cancer and solve humanity and it's going to do all these great things.

[00:19:26] And now they're like, no, we're going to address patient satisfaction. There's money tied to that. We can fix this one thing. We can use these tools in a really smart application specific way. And then mere mortals can use it. We're also seeing these. AI technologies get embedded in the systems of record, the industry standard systems that people use to make them better and more capable.

[00:19:49] I think we've been pretty spot on that we've seen, and we're seeing this transition from pie in the sky strategy in itself to a tactical use case that activates a strategy. You're going to see more and more of that. And we will see some killer apps. I don't think anyone's seen that develop yet, but the new life changing application is probably not that too far away as they start thinking about how do we solve specific problems versus looking at the entire world as if these tools are hammers and everything's a nail.

[00:20:24] Lastly, One of the predictions we talked about was what we call follow the data. We said data scientists will be the hottest new hire in PE firms and not AI engineer, but data science. And so the PE firms, as we've been seeing all year long, are not investing in neural networks. What they're doing is in a really, I think, smart and intelligent, appropriate way.

[00:20:47] They're investing in getting their data clean. They're analyzing it. They're visualizing it. They're using analytical techniques. And they're doing all of this in a way that will set the stage for neural networks, but they're very purposeful, very predictive, very deliberate. And so they're like, no, let's not try to go from no data to neural networks.

[00:21:09] Like let's set it up so that we can be successful, but also have ROI and not go chasing butterflies and rainbows and waterfalls. Let's do it when it's ready, but let's get ready before we need to use it. And then we're going to use these application specific tools. to really drive home the ROI. Now, what we thought's going to happen is that now P firms are going to start hiring lots of data scientists and the world of Excel is not going to go away.

[00:21:38] It's going to extend into Python and SQL and whatnot. And so we're seeing that the data is really hard to corroborate this, but just having a conversation with four other top operating partners. Very recently, I asked around the horn, it's like, how many of you in your firm have data scientists now? And everyone raised their hand.

[00:22:01] And then I said, how many of you had that like a year or two ago? No one did. So there is a lot of activity around data science, a lot of activity around getting ready for this surge, but activating the stuff that can be activated versus kind of trying to do the moon shots. And so intuitively we see this happening.

[00:22:22] We're seeing certain firms build out huge stables of this. We're looking for empirical validation that is happening kind of methodically and haven't been able to do that quite yet. For one example, you can look at as Blackstone has a team of more than 50 data science team members right now. It's pretty striking.

[00:22:41] The data will be there. The tactics are there. These AI tools are going to activate it. So I feel pretty good about our 2024 prediction so far. Some of it hasn't happened. With the speed and velocity that I think we thought would happen, but I think every one of these are certainly underway and will certainly be very important to the future development of the next cycle of this industry of business builders.

[00:23:06] Hopefully this gives everyone a good read on what we're seeing by virtue of being able to work with many hundreds of private equity firms, thousands of their portfolio companies, and equipping them with the tools and resources they need to execute on their strategies. And what I'd suggest, if you're a business builder out there, request our report, talk to a BluWave Account executive, because if you can replicate what the larger private equity ecosystem is doing, you're undoubtedly going to find elements of alpha that are going to get you out of a sea of beta that will enable you to get a little more edge on your competition.

[00:23:48] and build value with just a little bit more speed and certainty. I think when you read this, you'll see a couple things. One, you'll see that, Oh, we're doing a lot of this. That's going to make you feel good, right? Because you're validating a lot of the tactics and strategies that you're implementing. But I also guarantee you, you're going to find a couple elements of alpha and you're going to see a couple of things.

[00:24:08] You're going to say, Oh, I'm going to add this to my quiver of arrows so that we become bigger, better, safer, stronger, create more value the days ahead. So I hope this was valuable for our listeners here. If you have any questions, if you're a BluWave customer, please contact your account executive. We're happy to go into the data at deeper levels and do whatever we can to support your success.

[00:24:30] If you need third party resources to equip your strategies with the tactics, We work with the best of the best and have validated an ecosystem of service providers that can help you in a way that's really never been done before in the history of business. So If you're a P firm, we're happy to help you.

[00:24:48] If you're a portfolio company, we're happy to help you. But even if you're not, you can use us. We're not exclusive to the P ecosystem. It just so happens that the best business builders in the world use us a lot and so can you. So thanks for listening. Give us a call if we can support your success. Thanks.

[00:25:14] That's all we have for today. We truly appreciate your support. If you'd like what you hear, please follow 5 Star Rate. review and share. This is a free way to support the show and it really helps us when you do this. So thank you. Thank you. Thank you in advance. In the meantime, if you want to be connected with the world's best in class, private equity grade, professional service providers, independent consultants, interim executives that are deployed and trusted by the best business builders in the world.

[00:25:41] And so can you, or if you need anything else, get Give us a call or visit our website at BluWave. net. That's B L U W A V E and we'll support your success. Onward.

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.