VP of Investor Relations at Boron Capital, a private investment firm serving diverse segments of the population.
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Over six months into the Covid-19 pandemic, with social distancing regulations lifting and the economy starting to slowly move again, private market investors are waiting for great deals to hit the market. But projecting when and how the right deals will become available is growing increasingly difficult, because it’s not only a matter of investment-based analytics, but a question of how and when the government will create more stimulus.
Everything in the investment landscape is impacted based on which areas of the economy the federal government continues to support. As the government provides more stimulus and financial aid to businesses and individuals, it will continue to stall the effects of recession when it comes to actual asset pricing.
Due to this stimulus and intervention from centralized banks in the form of quantitative easing, asset prices are also showing less correlation with the overall economy. While GDP Q2 was down 32.9%, the stock market has risen to near all-time highs.
What does this mean for investors?
There is a possibility that asset prices will continue to hold on, in which case there won’t be a lot of distressed assets hitting the market any time soon. In the aftermath of the 2007-2008 financial crisis, a lot of distressed assets hit the market when investors didn’t have enough liquidity to buy. Today, it’s the inverse situation, where investors seem to have adequate liquidity, but they aren’t buying, because they’re unable to predict asset prices based on the economy.
However, the U.S. can’t experience massive drops in GDP and mass unemployment while stock prices rise in perpetuity. Eventually, there has to be a correction. And while larger real estate assets likely won’t move for some time, smaller businesses may become available for acquisition in the next three to 18 months.
Midsize business acquisitions may be on the horizon.
Private market investors looking for two and three-dimensional investments, where they acquire commercial real estate as well as the businesses that operate on that real estate, may see more and better opportunities to invest in midsize businesses over the next few months. These midsize investments could have long-term potential for appreciation as well as the short-term benefit of generating cash flow.
More investors might look to acquire midsize businesses (approximately $3 to $8 million) where they can immediately gain control of the operations versus larger acquisitions (over $25 million), in order to reduce competition from major buyers that are willing to overpay simply because they have capital they need to put to work. Private investors might still acquire multiple midsize businesses in portfolios, with each individual investment constituting a smaller deal.
Profit margin will be more important.
We may be more likely to see inflation over the next three to five years, in which case investors holding tangible assets will reap the benefits of proportionately higher asset prices and valuations. At the same time, investors may shift their focus to cash flow during this uncertain time.
Because the future is so uncertain, investors are more likely to pay attention to profit margin. Many businesses run so lean on their actual net profit that they’re unable to maintain sufficient cushion or capital reserves. Most businesses have a profit margin under 10%, but post-pandemic investors will be looking for businesses with up to 20 or even 30% profit margin, with a trend toward assessing an asset’s value today instead of betting on the future.
Liquidity will be key.
Instead of waiting for the best deals to hit the market, investors will likely shift their focus to collateralizing and making returns on their capital while reserving the ability to be liquid in a relatively short period of time, in order to capture better opportunities as they become available. Investments in short-term funds offering quick liquidity may take precedence in more incremental investment strategies as different asset classes hit the market.
Ultimately, Covid-19 will prove agility to be an investor’s strongest asset. While investment fundamentals – cash flow, collateralization, appreciation – remain the same, the application of those fundamentals can vary depending on what’s happening in the world. Because Covid-19 has had such a dramatic impact, investors must be willing to question their assumptions and look for opportunity where opportunity presents itself.
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