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No troubles seen ahead due to inflation

Supply chains are vulnerable

The COVID-19 pandemic is keeping the world on tenterhooks, and the private equity sector has not gone unscathed either. To begin with, global uncertainty resulted in market participants being less willing to invest – and rendered long-term forecasts for investments virtually impossible. Today, PE managers are suffering from the aftermath of the coronavirus pandemic, namely disrupted supply chains and increased prices – in layman’s terms: inflation. The past 24 months, however, have also shown us that private equity companies handled the external factors well, and were able to make the corresponding necessary adjustments.

No troubles seen ahead due to inflation
Together with FINANCE magazine, twice a year we canvass around 50 private equity professionals in Germany on their market views. In the past weeks, we asked them to evaluate the impact of the recent dynamic inflationary trend. Price increases do not overly worry managers, at least in the short- and medium term: only nine per cent of respondents are “very concerned”, whilst 61 per cent are “slightly concerned”, and for nearly one-third (30 per cent) inflation is no cause for concern whatsoever.

Supply chains are vulnerable
Whilst inflation barely worries PE professionals, supply chain issues are a far more pressing matter. With the container ship “Ever Given” blocking the Suez Canal in March 2021, the public became aware for the first time of how vulnerable international supply chains are. Since then, the situation has not improved – rather the opposite. It should thus not come as a surprise that supply chain concerns rank highest for survey respondents (as shown in the chart below). About a third of these professionals see the biggest problems here – by a long way. Second on the list is margin pressure on portfolio companies as a result of increasing input costs. Approximately one-third of respondents are “very concerned”; only 22 per cent, however, are “extraordinarily concerned”.

Inflation is accelerating existing trends
Increasing prices are mostly followed by increasing wages – and hence incur even higher costs. Around 30 per cent of respondents stated that they are “slightly concerned”, with only 17 per cent stating they are “extraordinarily concerned”. Very few managers see rising interest rates, and thus higher financing costs, as an acute problem. Only 15 per cent are “extraordinarily concerned”, whilst 48 per cent are “hardly concerned” or “not concerned at all”.

The question is: what is the market response? Concerns amongst private equity managers about inflation are also accelerating trends which, in principle, existed before: for example, cyclical sectors will be avoided for future investments even more than before, in order to reduce the portfolio’s susceptibility to macroeconomic developments. Nearly half of the respondents stated that they were planning to continue and intensify this strategy. “Asset-light” investments are a similar approach used by investors, mainly in the services sector. Here too, the main goal is to achieve greater independence from economic cycles. 24 per cent of private equity companies are aiming to circumvent looming price increases by securing financing at current terms, whilst 22 per cent seek to do so by accelerating current transactions.

When questioned about the potential impact of inflation on company valuations – whether such companies are in their portfolio or on their investment ‘wish list’ – half the respondents do not believe that valuations will continue to rise significantly. According to PE managers surveyed, equity investment prices are on a high level anyway, with only one-third of experts anticipating rising valuations.

“Stable pricing is obviously more favourable than an inflationary trend; at the end of the day, however, private equity will have to deal with the situation as it presents itself: it is our job to choose good companies and to help them grow,” says Torsten Grede, DBAG’s Spokesman of the Board of Management. “The more promising the companies, and the more potential their products and services offer, the better the performance – even in an increasingly demanding economic environment.”