Dear all,
I am writing this newsletter on my way back from the 2023 edition of the Milken Global Conference. What a great moment I had discussing the new paradigm in the Private Markets (and in dealmaking) and the shifts fostered by Data, AI, and Machine Learning in our economies (with what better persons than Eric Schmidt and Reid Hoffman themselves, who honored us with their presence at a panel on Tuesday).
There was a consensus that the Private Markets have profoundly changed over the last year, mainly due to macroeconomic shifts. The 5pp interest rate rise we have undergone in the past year to curb inflation is here to stay, perhaps with some attenuations, but only modest ones. This high-interest rate environment combined with high inflation is a new paradigm (at minimum, a sharp contrast with 2020-2021) with profound implications on dealmaking across all asset classes.
In Venture Capital first, where valuations are hit the strongest (-58% over the last 3 quarters in US Venture per Pitchbook). If the Power Law still applies to early-stage companies (and is perhaps even reinforced with the excitement over Generative AI), in-depth assessment of execution risk through surgical analysis of a company’s Unit Economics to assess whether profitability exists or is attainable has replaced growth at all costs. For sure, those companies whose growth is driven not by high-quality recurring (or re-occurring) revenue but rather by online ads will have (significant) trouble finding financing. And this is a good thing in my view.
Now on to Private Equity, where the impact of a 5pp environment goes beyond picking the right companies and questions the playbook at large. The new paradigm is forcing PE firms to commit to solid value creation plans at the portfolio company level through add-ons (representing the bulk of PE activity over Q1 23 per the latest Pitchbook data) and operational improvement plans. This playbook is not new per se – instead, it is ending a period where value creation was more accessible and often linked to multiple increases. However, one difficulty is unique and challenging to tackle: inflation. Understanding it clearly, and establishing scenarios for how it will impact portfolio companies from investment to exit is imperative and should be done with due diligence applying new lenses to assess resilience ultimately.
Last Strategic M&A, which is also facing its own headwinds, the strongest one being strong anti-trust pressures which were a topic of discussion on almost every Financial Markets panel.
In this paradigm, taking a long-term view of an asset is imperative, even when the road has never been traced in the case of high-growth and disruptive assets. In other words, investors should assess targets not just based on their current or past earnings but by taking a multi-timescale approach to gain a clear conviction of the company’s pathway to growth and profitability: will it reach its endpoint, and how bumpy will the trajectory be? Two key questions whose difficulty is perhaps reinforced by the inevitable impact of generative AI and ESG considerations on these companies and which make the overall assesment truly challenging (but so much more exciting).
Discipline and openness to change are my two key takeaways for dealmaking from Milken. Have a great read!