As the PE Industry Approaches its “Deal Cliff” – More Bad News

The IMF today published more bad news for the middle market and for the PE sponsors looking to find value in their aging middle market portfolios. The IMF today confirmed that the global economy was growing even slower than previously thought and will grow slower than previously thought for at least the next 2 years.

This is especially troublesome for middle market companies as we have found in our own primary research as well as in studies sponsored by the likes of KPMG, McGladrey, Bain, E&Y and others, that middle market companies sales mostly track with broader market trends. Unfortunately for the middle market and for their PE sponsors, we also have found that most middle market companies still do not have the marketing and sales sophistication needed to accelerate their own growth independent of their markets.

The most representative quote in our recent research that summarizes the middle market growth challenge is one from a recent E&Y study: “To grow and succeed in such an environment [a low beta market growth environment] will require that companies intensify their competitive efforts. Today’s market is demanding, oversupplied and increasingly price sensitive. Most growth will have to be won from competitors. There will be very clear winners and, equally, very clear losers.”

As we have blogged on numerous occasions, generating growth from middle market portfolio holdings is a seminal challenge for the PE industry. Value and leverage from operations improvement opportunities are dwindling, financial leverage plays have generally already been executed and value generated from broad market growth is nonexistent. In addition to all of the above, even without the needed expertise to generate growth is slow markets, most PE firms simply are loath to get involved in the management of their portfolios – especially in the areas of sales and marketing.

We have all heard of the fiscal cliff in the US economy that is approaching. We also think that a deal cliff is approaching in the US PE industry. Over the next 2-3 years, trillions of dollars in assets will need to be dealt even though those assets are below desired carry value. We wonder how low PE firms will have to go to sell the assets they simply must put into play. The lower they go, the lower the fund returns will be and the harder the PE industry will find it to attract their “mother’s milk” – new capital formation.

Our solution for PE firms and middle market companies – find growth in the top-line and find it fast!

To see the IMF study, click here.