Decoding Q3 Insights: Harnessing People Power and Growth Opportunities in an Improving Market

Sean Mooney:
Welcome to the Karma School of Business, a podcast about the private equity industry, business best practices, and real-time trends. In this episode, we're going to talk about our Q3 2023 Insights Report. We have a number of perspectives that show how the private equity industry is taking action in this topsy-turvy world that should instruct you, your companies, your businesses, on how to do some of the same. This episode is brought to you today by BluWave. I'm Sean Mooney, BluWave's founder and CEO.

BluWave is the go-to expert of those with expertise. BluWave connects proactive business builders, including more than 500 of the world's leading private equity firms and thousands of leading companies to the very best service providers for their critical variable on-point and on-time business needs. Enjoy. All right, we are excited to talk about today our Q3 2023 Insights Report. During this report, we're going to make a relatively bold prediction based upon the tea leaves that we're discerning from looking at industry, market fundamentals, and the proprietary data that we have.

The big headline that we're predicting is that we're seeing that the private equity industry is starting to throttle down likely meaning that they're calling a bottom, and we're seeing them take action to suggest that they see better things ahead versus worth things ahead when you take net-net everything into consideration. And why do we think that? There's a number of things that we're seeing and we'll drill down on each of these during this conversation.

First is that the private equity industry and we and others are seeing that while not maybe stellar and decidedly up in the right, the fundamentals are good enough to do deals right now and invest in companies. With that in mind, we're seeing the private equity then starting to really start investing in growth and then also meaningfully investing in people, which leads us to believe net-net that the PE industry is not acting scared. They're acting with increasing confidence, starting to do more, starting to accelerate and likely indicating that within all this noise there's a bottom.

So let's talk further about each of these trends in what we're seeing. And maybe as a precursor, let's talk about how the private equity industry acts. Study after study reveals that the private equity industry outperforms others throughout economic cycles, but particularly during down cycles. And the data will show particularly during these down cycles that private equity firms do best relative to other times where they invest, but also relative to the rest of the industry.

And the reason that we've seen this through peering through the behavior patterns in our own data, and remember this data that we get to see and we're privileged to see is a beneficiary of working with multiple hundreds of private equity firms, the world's best business builders, seeing how they behave, where they behave, why they behave, what actions they're taking, how this changes over time. And we've been tracking and monitoring this since 2018. And so at this point, we have five really good years of data that shows us a lot about how the industry behaves in aggregate.

And what this shows us is that the industry behaves in this approach that is similar to this concept called OODA loops for those of you who are familiar with Colonel John Boyd. It's a good read. But what we see that the industry does is they go through a sequence of forming hypotheses, gathering data, testing that data, taking action, gathering more data to see what happens, and then revisiting their action in and altering course, and then bringing that cycle throughout and returning.

And so if you think about an OODA loop, it's process of observing, orienting and analyzing, deciding and acting and doing this in rapid succession. By doing that, they're able to drive better outcomes, more empowered outcomes, more higher expected value outcomes than others. And so when we look at our data, we're seeing this kind of pattern where they're taking action, they're observing, they're orienting, design and they're acting. And when we look at it in aggregate in Q3, it suggests that they're accelerating, not deccelerating.

They're acting more offensively, more defensively. Let's drill down on some of the market moving trends, some of the fundamentals that we're seeing and others are perceiving. First, right now I think we're in this what I call a washing machine economy. It's a cycle of good news, bad news, good news, bad news, good news, bad news, and it's really easy to get wrapped up in that.

But if you pierce through this noise and you pull yourself up to 35,000 feet and you give yourself a little more perspective, we're seeing a few things that lead us to believe that things are getting better versus worse, and we think that private equity is seeing the same. Number one, inflation's cooling. At least as of August, the Consumer Price Index, CPI, was less than half of what it was a year prior. The September day is coming out at the time of this recording, and while it's showing it bobbing up and down a little bit, it's still markedly better. Now, we still have a ways to go on inflation.

That last mile is still going to be hard, but it's getting a lot better. The next thing that we're seeing is that GDP is growing sufficiently. When we look back over time, there were two negative quarters of GDP in Q1 and Q2 of 2022. Hot take here, I think there's a greater than 0% probability that the Federal Reserve in retrospect says, "Oh yeah, we're actually in recession in Q1, Q2 of 2022," and that was the recession, because the Federal Reserve is never going to tell anyone that we're in a recession while we're in it, because then that'll make things worse.

Now, since Q1 and Q2 of 2022, we've had four quarters of positive GDP growth and we have an expectation that we will continue to have positive quarters of GDP growth. Now, is it through the roof barn burner GDP growth? No, but it's good enough and that's what we're seeing, and that gives you a foundation for being able to take action, the confidence to do so. The next thing that we're seeing is that consumer sentiment remains robust. If we look at the University of Michigan Consumer Sentiment Index, it shows that it was at 68.1% in September of 2023.

That compares to 58.6% a year earlier in September. So that's a 16% increase in confidence year over year. Consumers certainly have things that we have to be mindful of. Do they begin saving? Do they stop accumulating debt? Is debt too unsustainable? Those are things we have to watch, but net-net they're still growing. And then you look at what groups like Goldman Sachs were often quite good at understanding what will happen, they recently reduced their chance of recession in 2024 from 20% to 15%.

And so there's a lot of things just macroeconomically within all of this noise that suggests that things are "good enough." And so let's look at how that's translating into the deal market. One, we're showing that deal flow is getting better, particularly post Labor Day. The first half of this year in 2023 was very unexciting. It was soft. It was low. After Labor Day of 2023 this year, we've seen a marked improvement in the quality and quantity of deal flow that's actionable. And part of the reason it's actionable is because we're also seeing the debt market strengthening.

Large commercial lenders and banks are not necessarily providing all sorts of volume to the M&A markets, but the private debt market has stepped up substantially. And so if you look at the PitchBook data, you are seeing sequential strengthening in each of Q1, Q2, and Q3 of this year. Now, if you have the debt that's available, deal makers and private equity can actually do deals because it's not... And let's put this in perspective. This isn't 2019, 2020, 2021 levels of debt, but it's enough.

It might be higher price than what it was a year ago. It might be lower leverage multiples. It's actually probably closer to what a traditional deal economy looked like over time, but the debt is there. It's predictable and it's stable for companies that are good. And so as we talk with our investment bankers in our ecosystem, with the private equity firms within our ecosystem, the consensus is universal and it's good, it's good enough, it's improving. It's not barn burner top of the cycle. And newsflash, we're not going to see that top of the cycle probably for another five or six years like we do every cycle.

I think the differences going forward is we're going to be more in a traditional five, six, seven, eight year economic cycle, not this 15 year Fed free money fueled supercycle that we've gone through since 2009. And so we're going to be in a normal kind of cadence, probably more of a normal deal market, but the deal market is good enough. So with these precursors in place, what are we seeing in our data?

Really interestingly, as we look at our Q3 2023 data, which reflects the projects that are demanded by private equity firms and the resources that are used to enable them, which is why people use us, is that we're seeing a 20% increase in year over year demand for private equity grade service providers that can help their portfolio companies accelerate growth. Why is this important? The private equity industry appreciates that top line growth is the most significant contributor to enterprise value creation.

And they know that if you're not growing, you're not going to increase your enterprise value and you're not going to sell for top dollar. And so what we're seeing them do is hit the gas, not full throttle, but they're increasingly putting more and more gas to increase acceleration of their portfolio companies so that they're at or near full speed or certainly approaching full speed as the economy decidedly reenters its next phase of growth.

And so we're seeing acceleration in the usage of private equity grades, consultants, advisors, sales and marketing professionals, that can help their portfolio companies grow faster. And that's really important. And so that's a signal that they're moving from defensive to offensive. The next big signal that we're seeing, which is really important, is we are seeing the private equity industry make a massive surge in human capital activity. And what does that mean? These are recruiters.

These are senior advisors. These are interim executives. These are people that are bringing unique and more and varied and different skill sets to the private equity industry and their portfolio companies. So in Q3, 2023, what did we see? Pause on this and take this in. We saw that the private equity industry demanded a 36% increase in human capital resources compared to the same quarter last year. Now, take that, that's a 36% increase. That's huge. No one expect that, but we're seeing that the private equity industry is hiring in droves.

What's interesting as we peel back the onion here is they're, of course, still bringing in wartime generals, and so we're not fully through the chop. But we're seeing them pivot the mix away from largely wartime generals maybe during the last year up until this quarter to more of the strategic, growth-minded, future-looking executives that are peering for this kind of growth mindset that we're seeing also on the growth side of the equation. And so you're seeing a pivot in the mix of the mindset of the people that are looking forward versus like, we need to protect the foundation.

And so that is I think another signal that they're bringing in people that are having confidence to hire. They're looking forward versus backward or living in the near now. And to frame all of this, of course, this is not uniform across everything. This is just a tilt in the mix and what this shows us is that we're probably bottoming out and then we're heading into a growth phase. And let's all be mindful. The road forward is not going to be a straight up into the right.

We're going to see winding lefts and turns and pauses and hitting the gas, but we're seeing the direction of the curve turn from down to flat and pointing up again. And time after time when we look at the data, as we talked about earlier, the private equity industry comes out of these down periods earlier than others. So as we read these tea leaves, it's showing us things are probably going to be getting better versus worse while acknowledging we're still at probably this bottom area.

Not everyone's going to be bright and shiny. One of the other things that's really interesting that we're seeing is that the private equity industry is not only getting more involved in the C-suite with a lot of activity in that area, we're seeing the private equity industry get much more directly included in partnering with their portfolio companies down to the mid-level. And so we're seeing mid-level hiring activities involving private equity firms and their portfolio companies starting to go through the roof candidly.

And part of that is there's this whole trend where private equity firms are mapping their talent strategies to their value creation strategies and private equity firms are seeing in order to enable a certain bucket of growth within their value creation strategies, they need to equip their portfolio companies with skill sets not only at the C-suite, but all the way down through the middle and lower levels. So the private equity firms are getting much more deeply involved there, and they're upgrading top-grading, adding incremental people and roles where they have big opportunities.

So that's an interesting aside that we're going to see more and more of, I believe, in the days ahead. Take this all together, what are we seeing? Private equity industry likely calling a bottom. We're starting to see them throttle. They're doing so because the fundamentals are good enough. Because the fundamentals are good enough, they're investing in growth and then they're investing in people. So one of the things that's given me cautious optimism and frankly why we're also throttling down here at BluWave and we're not doing it blindly.

We've got our foot on the gas, but we're also ready to turn left and right. I think as a signal to other CEOs, other investors, other people in our broader ecosystem, this is something that if the best business builders in the world are doing it, you might want to pay attention. Now, what should we take a look at and maybe watch out for? Because I think that's equally important. Like what we said, this is going to be a lot of lefts and a lot of rights and hitting the gas, but also hitting the brakes.

And so the things that we're looking at, I think the private equity industry is also looking at, is inflation, number one. We want to make sure that these confluence of challenges with OPEC+ starting to pull back their pumping and not doing their volumes. The US shale producers have thus far showed a reluctance to add meaningful new capacity, even though we have quite high oil prices right now. There's certainly challenges with our US oil policy.

And so we want to make sure that inflation is not going to be put back into an escalation pattern because of oil and gas, which is a large part of the overall equation. The other thing that I think the Fed is certainly watching a lot is inflation related to wages and labor. And so we're keeping an eye on that. I think, like we said earlier in the podcast, that the last mile is usually the hardest, but keep an eye on that as well. The other thing that we're watching out is China. China has been the tailwind behind the world economy since it joined the WTO a long time ago.

It's fueled global growth. It's because of the way that it was adding productivity and low cost. It also kept inflation at check during the last 23 years before at least maybe the last year or so. And so global decoupling is having certainly an impact. The real estate industry in China is having issues. Geopolitics certainly are putting issues here. So we want to keep an eye on China to make sure that there's not global spillover as it relates to the policies that they're implementing and hopefully the amount of stimulus that they're bringing in to get their economy going again.

The next thing that we're looking at is the US consumer. So thus far, the US consumer has proven to be amazingly resilient, not withstanding everything we're seeing with interest rates, et cetera. And so if the US consumer continues to mount unsustainable amounts of debt or meaningfully flips into savings mode, we certainly want to keep an eye on that. And that could also cause the Fed to introduce stimulus earlier than it would like to, which not necessarily a bad thing if we get stimulus earlier.

One of the last things that we're really keeping an eye on is commercial real estate. Obviously, as all of us know, post-COVID hybrid work, virtual work has dramatically impacted the usage of office space. So at the same time we've seen utilization go down. There's been a sea of debt coming due in the commercial real estate industry, lots of square footage added, interest rates meaningfully higher. So the combination of interest rates, low utilization, declining lease rates, this could cause a lot of trouble and likely will within the commercial real estate sector.

And so we're keeping a lookout for possible contagion. The last bold prediction that we have that is something to keep an eye out for is that there's enough noise as we're navigating these lefts and rights into an eventual recovery that's much more all lights being green is that there's still enough risk here. And the Fed might actually start stimulating before many of us think. And so history's a useful instructor here. And this 2% target that the Fed adopted was almost an arbitrary following of a relatively obscure central baker in New Zealand that put this target of 2% in place in 1989.

Before then, there's a lot of argument, should it be 2%? Should it be 3%? Should it be 1%? It's been a moving target for years until 1989. I think the Fed has demonstrated that they're still really looking for 2%, but I would not be shocked if the Federal Reserve either changes the inflation measure that it uses to instruct policy or if it just changes the hurdle level so that they can get back to introducing stimulus earlier. I wouldn't say it's a probability, but it is certainly a possibility.

So keep an eye on that. Lastly that we are just keeping a lookout for, never underestimate the power of a major election cycle and a presidential election. You're going to have both parties equally interested in having a stronger economy next year with both sides up for reelection, and there's nothing like the power of a major election year to provide the incentive to heavily try to persuade the Federal Reserve to do more rather than less to help the economy come out of this washing machine that we've existed in for the last couple of years.

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 of the things that you can add to your toolbox to do the same. Special thanks to our listeners for joining us today. Please continue to look for us anywhere you find your favorite podcasts, including Apple, Google, and Spotify. We truly appreciate your support. If you like what you hear, please follow, rate, review, and share.

It really helps us when you do this, so thank you in advance. In the meantime, if you need to be connected with the world's best in class, PE grade professional service providers, independent consultants, interim executives, or anything else, please 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.