Today’s challenging circumstances show no sign of abating in 2024, making the ability of active investors and their companies to drive operational improvements absolutely crucial.

The supply-side shocks and inflationary pressures catalysed by events of the last three years have given way to interest-rate hikes globally. This has impacted households and businesses alike trying to service debt, and caused a slowdown in private equity (PE) transactions as firms both ‘wait and see’ prior to signing new deals, and divert their attention towards nurturing existing portfolios to navigate the current backdrop. We expect the repercussions of this trend to continue into 2024.

This is true for AURELIUS too, but only to some extent: in 2023, our PE mid-market teams have, amongst other transactions, acquired LSG Group from Lufthansa, ECO3 from Agfa, and sold Distrelec to RS Group.

We expect investment activity in the market as a whole to remain subdued for 2024. At the same time, the transactions that do take place will likely lead to excellent value creation as the year presents opportunity for a strong vintage.

So we will remain proactive, with complex carve-out situations and companies remaining our primary focus owing to the high potential for operational improvement they offer.

PE adds value beyond capital…

Why? Because if the last few years have shown anything, it is that the PE industry is proving itself a strong custodian of businesses, bringing experience to bear across economic cycles to support management teams for whom this may be their first downturn, and guiding them on operational improvements when other typical PE value levers such as multiple expansion and leverage are unavailable or unattractive.

Clearly there will be funding challenges for many companies in 2024, particularly in the mid-cap segment. The strong relationships PE backers have with lenders, both banks and non-banks, can often secure favourable terms for their portfolio and assist with negotiating with lenders should that be important. This is more topical than ever, with many traditional lenders putting the brakes on lending, and/or demanding onerous terms. We think these relationships will enable many of 2024’s financings and our private lending business AURELIUS Finance Company (AFC) is in a strong position to do just that.

…if they have capital

There have been claims that there will be a precipitous decline of our industry in the coming years with some pundits predicting a dramatic consolidation of our industry to just 100 firms within the next couple of years. We think these claims are greatly exaggerated. What we do expect to see, however, is a bifurcation of PE houses: those able to back new opportunities as proven track records support well-capitalised firms to transact, and those unable to raise fresh funds forced to re-assess their position. AURELIUS is very well capitalised and a proven specialist in operational transformation, so we will certainly be in the former camp.

That said, we expect some of our peers will have to explore fresh ways to fund interesting transactions, such as deal-by-deal funding, vendor loans, GP financing or more co-invest. We have no need to enter into such arrangements and do not intend to.

Hands-on value creation with proven principles

In the meantime, the road ahead for existing portfolio assets is about stabilising businesses and preparing them for a return to growth. Once again, with two of the three levers previously embraced by PE – multiple expansion and leverage – unavailable in today’s market, success comes down to the third and only lever still accessible: operational excellence. Only houses with this proven experience can play a real role in growth by helping businesses to navigate the challenging time ahead so they emerge stronger. AURELIUS is one such house.

Our track record is built on this as our key value driver since we started investing in 2005, with the recent success of Distrelec highlighting the substantial benefits this can have. Our carve-out from the Dätwyler Group and subsequent transformation saw profits grow ten-fold at Distrelec in the space of less than three years, overlapping the pandemic. When we sold Distrelec to RS Group plc in Q2 2023, we generated an outstanding double-digit MoIC return for investors. The transformation process employed our usual principles: implementing an operational transformation, digital enhancement, and international expansion and acquisitive growth, whether transformational or accretive.

Corporate activity to drive opportunities

In fact, next year’s transaction activity will be driven not only by how PE firms respond to the challenges the economic and geopolitical headwinds pose, bus most certainly also by how large businesses react. We expect them to create opportunities in many ways – by pursuing corporate and financial M&A as they re-assess strategic priorities and look to divest non-core areas. This creates a space for PE backers to acquire previously unloved, high-potential assets and to give them the nurturing they need to thrive as operationally transformed successes.

This trend may well gain further momentum from regulatory pressure on businesses to offload assets, as we’ve seen multiple times in recent years, for example with JD Sports being forced by the UK’s CMA to sell Footasylum in 2022. Footasylum’s journey thus far under our stewardship shows how the right backer can accelerate success against all the odds with the right mix of investment and expertise: the company is expanding its store footprint both in existing sites and by launching new ones, including a 20,000 square foot fresh flagship on London’s Oxford Street in September 2023. The journey of the omnichannel retailer has shown that bricks and mortar isn’t dead, it merely needs reinventing, as Footasylum has done by pivoting to a disruptive entertainment model in-store and blending on- and offline shopping to create a seamless customer experience.

We think the coming year will present more such opportunities, whether owing to regulatory pressures or indeed as a result of voluntary strategic decisions by parent companies to release some high-potential businesses in order to focus more on core activities. Many units still languish within larger entities and fail to reach their potential, even in favourable backdrops, as they are often under-invested. Fresh PE backing can usher in meaningful growth as those units become a true priority for their new owners. We’ve seen what a big impact a focused investor can have with an erstwhile unloved captive with the transformation of AAH, part of Hallo Healthcare Group, which Aurelius carved out of McKesson in 2021.

In the 2.5 years since then, the distributor of pharmaceutical and healthcare products has seen profits grow by nearly a third. This is the arena in which we intend to continue to play.

There is also an appeal for having tangible assets as security for loans in a challenging backdrop. This is an area we understand well owing to our debt business’s asset-backed element and the benefits that has created. AFC is in the process of becoming one of the leading private-debt players in the UK market, having deployed GBP150m in 25 transactions since its inception in 2017, and currently has an active loan book in excess of GBP 100m. We are confident the fast-growing business is at an inflection point, with plans to materially increase its deployment in the years ahead.

ESG playbooks to actively support the portfolio

As PE continues to back an increasing number of high-growth businesses, it will play a bigger role in helping to push the ESG agenda. Initially because of investor pressure and increasingly because it has become clear that it’s a real value driver when it comes to exit. Investors can help portfolios to progress on their ESG journeys, whether just starting out or helping firms more established in their ESG focus to continue improving. The diverse portfolios of many PE firms mean sharing knowledge and experience in this fast-moving space can be invaluable.

AURELIUS has developed a standardised ESG Playbook to effectively support our portfolio companies as they progress on their ESG journeys. Two of our major solutions are in the fields of sustainable supply chains and ESG reporting. They were created in response to growing demands from stakeholders for ESG data and upcoming regulatory requirements.

We are confident that the period ahead will be marked by a focus on operational excellence, and that a real polarisation of the PE space is about to play out, as those who have proven experience here are able to apply it successfully to fresh opportunities and those who have been relying on multiple expansion and leverage may find they cannot repeat this in today’s backdrop.

Our 340-strong team includes over 150 operational specialists, with our focus since inception on undertaking complex transactions and improving businesses through operational transformation.

The AURELIUS playbook is best placed to steer businesses to success in the challenging years ahead.