The adoption of artificial intelligence is contributing to outside-in due diligence becoming a prerequisite for potential exits rather than just being a differentiator, Severin Matten, director and member of 3i’s global healthcare team, told PE Hub Europe in the latest of our outlook Q&As with private equity dealmakers.
3i’s own exits in 2023 include its infrastructure business agreeing along with co-investors in July to sell Attero, a European waste management business, to private equity firm Ardian at an enterprise value of around €1.5 billion.
Matten also expects to see more pharma and life science deal activity in 2024 after a “rather muted” 2023. Matten works in the Frankfurt office of London-headquartered 3i.
Do you expect a pick-up in dealmaking in 2024?
An uptick in PE dealmaking in 2024 is likely, driven by stabilised market conditions and growing pressure for GPs to exit older investments and deploy capital from funds raised in 2019-22. The macro outlook, starting with GDP forecasts, has settled on a no/low growth environment, inflation appears to be under control and interest rate hikes have stopped. All this provides a new base from which deals can be negotiated.
My conviction is that these conditions will drive a bifurcation of deal opportunities, with those companies showing traditional leveraged buyout characteristics of strong market positions, above-market organic growth and solid free cash conversion still commanding high valuations, but companies not ticking all of these boxes likely seeing valuations below last-five-year averages.
Having a thorough understanding of specific subsectors will enable GPs to fairly evaluate businesses and drive value-add opportunities where other market participants will abstain. Equally, those funds that can offer strategically valuable support and bespoke capital solutions to businesses will be at an advantage since the cost of debt will remain high and debt availability will continue to be influenced by macro events.
Thus, by executing investments from our own balance sheet and having strong conviction in specific subsectors, we feel 3i is well placed for the 2024 dealmaking environment.
How was your dealmaking experience in 2023?
The 2023 dealmaking environment was driven by a high level of market transparency on relatively few opportunities. This coincided with a flight to high-quality and less cyclical sectors like healthcare, software and services. Auction processes in these areas continued to be run in their traditional format but often experienced prolonged timelines in light of pre-2023 valuation expectations, market uncertainties and increased levels of due diligence. That said, trophy assets still saw pre-empts or multiple bidders competing on binding offers. The latter was also a function of a lot of pre-deal preparation done by funds since the start of covid.
Generally, thorough outside-in due diligence for upcoming exit processes, especially for PE-owned companies, has probably moved from being a differentiator to becoming a prerequisite to successfully compete on sought-after assets. A contributing factor to this is the use of AI and technology platforms to accelerate due diligence. This is certainly true for large and upper-mid cap transactions but is starting to creep into the lower-mid cap market. As a result, GPs need to be selective on where they want to play, and focus their resources accordingly.
Which healthcare subsectors do you expect to do well in 2024 and which will struggle?
My expectation is that we will see more pharma and life science-related deal activity in 2024 in 3i’s core geographies of Europe and North America, after this was rather muted in 2023. Partially, this is due to a normalisation of underlying R&D activity and funding thereof after the covid hype. While it might take the first half of this year for an upward trend to solidify, the long-term trajectory for pharma innovation is positive. Through 3i’s investments in SaniSure and ten23 health, we have seen how these two trends played out at two different points of the pharma value chain, with a promising outlook for both companies in 2024.
Last year was still reasonably active in the medtech sector, which remains one of our key areas of focus. After seeing some of the most significant up and downward spikes in the early stages of covid, the sector stabilised and dealflow improved. The EU Medical Device Regulation, combined with generally growing levels of regulation, remains an area of concern for [original equipment manufacturers], their suppliers, service providers and investors in the space.
Next to regulation, digitalisation and robotisation are attractive long-term trends in medtech that 3i portfolio companies Cirtec Medical and Q Holding benefit from. Against that backdrop, I expect deal activity to remain stable for 2024.
Similarly, market activity in healthcare services was also reduced in 2023, particularly in Germany where a political debate put the investment thesis around medical practice roll-ups at risk. However, these concerns have not yet materialised and investor confidence around these types of deals has improved again. Fragmentation in healthcare services remains high and consolidation alongside expected efficiency gains should ultimately deliver a better standard of care to patients.
The 2020-23 period has demonstrated that while the healthcare sector in aggregate is fairly resilient, individual subsectors can be more volatile than is commonly believed. So even though more PE investors are looking to invest in healthcare, these learnings have made financial sponsors more selective and could possibly reduce valuations for those subsectors that have proven less resilient. That said, even these subsectors will likely continue to command a premium compared with other end-markets.
Do you expect an increase in take-privates in 2024?
While we have seen a few interesting public-to-private transactions in the healthcare space like Instem, Ergomed or va-Q-tec, take-privates were not abundant in 2023 and I do not expect a strong uptick in 2024. Partly because public market valuations have remained at, or returned to, relatively high levels when taking into account the current cost of equity and debt.
Furthermore, the execution of public-to-private transactions remains complex, with an often-uncertain transaction outcome. Thus, we will continue to see asset-specific opportunities but I do not foresee a widespread market opportunity.
What’s your outlook for exits in 2024? Do you expect a pick-up in IPOs?
The previously mentioned deployment pressure for buyers paired with increased discrimination between more and less attractive buyout candidates will make for an interesting exit environment in 2024. I expect the volume of processes to go up, however with lower transaction certainty. The latter will be driven by sellers’ price expectations and buyers’ selection criteria. IPO windows have been fickle and short-lived in 2023.
I expect some improvement in 2024 as long as geopolitical challenges like Russia-Ukraine, Israel-Gaza, China-Taiwan-USA or growing conflicts in Latin America do not worsen. Thus, we should expect a fairly stable mix of exit routes, potentially with a slightly growing share of financial exits.
Editor’s note: PE Hub Europe is running 2024 outlook Q&As with senior private equity dealmakers through December and January. The previous instalment was with Gabriel Caillaux, co-president, global head of climate and head of EMEA at General Atlantic.