Private Equity Pivot: Shift to Asset-Heavy Firms as Capital Costs Climb
S&P Global insights suggest private equity is moving toward asset-heavy firms and lower leverage due to rising capital costs and inflation.
The landscape of global private equity investment strategies is bracing for a fundamental transformation. As the world moves away from a consumption-led growth model toward one centered on resilience and massive capital expenditure, investors are expected to pivot toward asset-heavy businesses, embrace lower leverage, and commit to longer investment horizons.
These insights were shared by Thomas Friedberger, Deputy CEO and CIO of Tikehau Capital, during an episode of the S&P Global Private Markets 360 podcast. Friedberger highlighted that the global economy is currently transitioning, necessitating a rethink of traditional investment playbooks.
The Impact of Rising Interest Rates
A primary driver for this shift is the current high-interest-rate environment, which has significantly increased the cost of financing. Friedberger noted that the traditional private equity reliance on financial leverage and valuation multiple expansion is becoming increasingly difficult to sustain.
In this new climate, investors are likely to adapt by:
- Reducing Leverage: Moving away from heavy debt-funded acquisitions.
- Extending Holding Periods: Keeping assets for longer durations to realize value.
- Active Portfolio Management: Focusing more intensely on operational improvements at the company level.
The Drive for Economic Resilience
The shift toward asset-heavy companies is fueled by a global necessity for governments and corporations to strengthen their core infrastructure. There is a massive increase in capital requirements to bolster:
- Supply chain stability
- Energy infrastructure
- Defense capabilities
- Economic sovereignty
Friedberger pointed to "hyperscalers" and recent massive investments by tech giants like Google as prime examples of this trend, noting the significant need for these entities to issue debt in capital markets to fund their expansions.
Inflationary Pressures and Economic Headwinds
While the transition toward resilience is necessary, Friedberger warned that it could lead to a complex economic environment characterized by slower overall growth and persistent inflation. Several factors are contributing to these inflationary pressures:
- Increased government fiscal spending.
- The trend of moving production closer to the end consumer.
- Higher requirements for insurance.
- Increased spending on infrastructure.
Interestingly, the rise of Artificial Intelligence (AI) presents a paradox. While AI has the potential to lower costs in the long run, Friedberger suggested it could exert short-term upward pressure on the prices of electricity and semiconductors.
A New Focus on Management Quality
As companies become more capital-intensive, the criteria for selecting successful investments are changing. With borrowing costs remaining high, the ability of a company's management to allocate capital efficiently becomes paramount.
The focus is shifting toward the quality of management decisions—specifically where and when a company invests its capital—as the primary driver for generating returns from large-scale investments.
The Rise of Private Credit
Amidst these changes, Friedberger noted that private credit is well-positioned for growth. He indicated that this specific market continues to enjoy strong tailwinds and is expanding across both Europe and the United States.