AI takes center stage as private equity investors turn to value creation – Alvarez & Marsal

June 19, 2024 (Preqin News) – Declining deal-making, shrinking buyout multiples, and a growing exit backlog. These are a few of the factors causing ‘a headache’ for private equity GPs listed in Alvarez & Marsal's (A&M) Transformation in Private Equity report.

Higher interest rates, scarcer capital, and macroeconomic uncertainty have led to persistent valuation gaps, with deal-making and exit numbers both declining. This backlog is leading to challenges for private equity firms, including managing balance sheets of aging companies and creating value from companies while waiting for exit valuations to improve.

A&M found that 79% of private equity investors are adapting to the current macroeconomic environment by finding new opportunities for value creation beyond cost-cutting. The tough exit and deal-making environment means that organic growth is a favored strategy over acquisitions, with 32% of investors favoring the former over the latter (although buy-and-build remains relevant).

Strikingly, almost all respondents (97%) see digital infrastructure as key to implementing a value creation plan, up from 84% last year. AI is a large part of this, with 45% of investors already using AI in post-acquisition value creation plans, and 38% planning to do so by 2025.

Investors are relying more on data and AI to determine both where value is being lost and where it can be found. When AI is used, the main areas are to gain market insights and in competitor analysis (87% of use cases), strategic decision-making (79%), financial management (70%), operational efficiency (45%), customer experience enhancement (42%), and human resources (11%).

How are you using or planning to use AI in value creation plans?

_{Source: Alvarez & Marsal, Transformation in Private Equity}

A&M’s survey also explores ESG considerations in private equity portfolios. Nearly two-thirds (62%) of respondents said improved ESG credentials boosted the long-term performance of portfolio companies.

Measuring the relationship between ESG and performance is difficult, in part because of a lack of historical data. However, early indications from Preqin’s ESG fund performance benchmarks support respondents’ views in the A&M survey. Funds labeled Article 8 under the EU’s Sustainable Finance Disclosure Regulation (SFDR) deliver returns in a narrower range, with less likelihood of large losses than the average private equity fund.

For example, a pool of 15 2020-vintage SFDR Article 8 vehicles reports a median net IRR of 16.3%, with the lower quartile boundary at 8.4% and the upper quartile boundary at 26.6%. The comparable pool of 517 private equity funds has lower returns at all quartile boundaries, standing at 7.9%, 14.9%, and 25.1%, a pattern repeated by 2021 funds.

A&M said that qualitative answers to the survey suggest that funds are now moving to embed ESG into portfolio companies’ activities pragmatically, combining cost optimization with environmental objectives, or investing in sustainable products to access new markets and improve brand loyalty. ‘We see this as a significant shift, signaling the industry may be transitioning from a purely value-preservation (risk management) lens towards a value-add approach when it comes to integrating ESG in their portfolio companies,’ the report said.

_{The opinions and facts included within the above do not constitute investment advice. Professional advice should be sought before making any investment or other decisions. Preqin providing the information in this content accepts no liability for any decisions taken in relation to the above.}