The gathering pace of digitalisation, impact of generative AI as well as market and economic conditions should lead to an “exciting 2024”, Paul Morrissey, senior managing director and head of Blackstone Growth Europe, told PE Hub Europe in the latest of our 2024 outlook series with senior dealmakers.
A normalisation of valuations in 2023 was healthy for the growth equity market and the valuation gap should narrow further next year, he added.
“Less liquidity means companies were much more focused on profitable growth in 2023 in comparison to a more ‘growth at all costs’ mindset which was more prevalent before 2023,” he said. “Many of the most interesting companies we spent time with this year showed margin growth which was significantly in excess of revenue growth in 2023.”
What were the highlights in growth equity for you in 2023?
A major highlight was the widespread adoption and advancement of generative AI. Its impact on creative industries, marketing and software development has been significant, opening up an array of new investment opportunities. The ability of generative AI to produce original, high-quality content quickly and efficiently has transformed operations in sectors such as advertising, entertainment and education. This has led to a surge in growth equity investments in companies leveraging these AI capabilities to offer more innovative products and services.
At Blackstone, we have been thinking about this trend for many years and started hiring our first data scientists in 2015. Today that team of data scientists driving much of our AI initiative is over 50 people.
In 2023 we saw market valuations return to more normalised levels after a higher valuation environment. This correction was healthy for the growth equity market, allowing for more prudent and sustainable investment strategies (with the exception of GenAI related investments).
This convergence in valuations back towards historical norms was the result of less liquidity in the market. Less liquidity means companies were much more focused on profitable growth in 2023 in comparison to a more ‘growth at all costs’ mindset, which was more prevalent before 2023. Many of the most interesting companies we spent time with this year showed margin growth which was significantly in excess of revenue growth in 2023.
What challenges were there?
Rising interest rates has been without a doubt one of the biggest challenges, and the response of central banks to inflation has exposed growth equity’s sensitivity to higher rates. We saw this particularly in the first half of 2023 when transaction volume for late-stage growth equity significantly slowed as the market digested the implications of a higher interest rate environment, with a stronger focus on profitability than on top line growth.
Do you expect 2024 to be better or worse for growth dealmaking than 2023?
It was a challenging year for both entrepreneurs and investors. We saw a number of companies re-evaluate their fundraising strategies and further streamline operations. Moreover, we saw investors nurse the pains of multiple compression in their existing portfolios. This phenomenon prompted a period of careful portfolio reassessment and strategic adjustments, which in turn reduced the amount of new capital deployed. However, despite these challenges, we have seen many companies and investors successfully pivot and adjust to the changes that we’ve been confronted with.
While 2023 was a year of significant challenges and strategic recalibrations, it has set a robust foundation for an exciting 2024 in the growth equity sphere. The combination of accelerating digital transformation, the ‘generational’ progress of GenAI models, economic adjustment and market recalibration presents a unique and promising landscape.
Has growth also suffered from a valuation gap like M&A? Did you see this narrow in 2023 and do you expect it to narrow further in 2024?
Although we have certainly seen a valuation gap since inflation became a relevant economic driver again in late 2021/early 2022, this gap has narrowed. This has been driven both by companies ‘growing into their valuations’, as well as pragmatic entrepreneurs and investors facing reality head on.
While we predict the gap will continue to narrow further for companies in 2024, we do not believe this to be driven by an increased abundance of capital. On the contrary, we expect capital to remain scarce and meaningfully more expensive than in the last cycle.
We’ve continued to be rigorous in our approach to valuing companies based on actual performance, in line with where comparable companies are being valued, ensuring that we are setting up the business for long term success as they grow.
Which sectors/subsectors do you expect to be particularly attractive in 2024 and why?
Artificial intelligence and machine learning will continue to present interesting investment opportunities, as businesses across all industries explore how it can drive greater growth and efficiency. We established a data science group in 2015 and are expanding our capabilities in artificial intelligence, and continuing to identify opportunities to invest behind this mega-trend.
Cybersecurity is another attractive sector. As digital transformation accelerates, so too does the critical need for robust cybersecurity solutions. That’s why we are focusing on important subsectors like threat intelligence, prevention and response, cloud security and AI-driven security solutions.
Another notable subsector is fintech, specifically digital wallets and payment platforms. This is being driven by the global shift towards cashless transactions and the growing adoption of mobile commerce.
Finally, we are continuing to see demand for vertical specific software solutions, so I expect this trend to continue into 2024 and beyond.
Editor’s note: PE Hub Europe will be running 2024 outlook Q&As with senior private equity dealmakers through December. The previous instalment was with Francois Aguerre, partner, co-head of investment and global head of origination at Coller Capital.