Churchill’s Randy Schwimmer: Supply chain disruptions are a “daily battle, but sponsors now have the playbook”  

PE Hub’s Outlook 2022 Q&A series with high-profile private equity professionals continues today with insights from Randy Schwimmer, co-head of senior lending at Churchill Asset Management and founder and publisher of The Lead Left.

Many private equity sources tell us 2022 will be another banner year for private equity. What’s your outlook?

No question about it. The same elements that drove last year’s deal activity momentum – record dry powder, pent-up demand for assets, and a well-defined sector path for growth – remain present for 2022. The hottest industries – tech, software, healthcare, and business services – also have the best credit outcomes across cycles. Our focus on those sectors thus rewards us with both strong deal flow and conservative risk profiles.

How will rising interest rates affect PE-backed loans?

Interest expense is always the first item to be impacted, which in turn compresses interest coverage ratios for borrowers. But a rising rate environment is often prompted or accompanied by higher economic growth. Improved revenues and profitability will then offset any higher borrowing costs. The 2022 outlook for Fed rate hikes, though, only gets you to a 1 percent Fed funds rate – which pales in comparison to June 2007’s 5.25 percent level.

How will inflation affect PE deals?

This is very industry- and cycle-dependent. And even with sectors, each company has a different cost profile. Where are they in the supply chain? How do they source product? What’s the labor component of their cost structure? How exposed are they to energy or commodity increases? We look closely at a borrower’s ability to pass along these costs to the customer.

Some PE firms are saying there’s demand for their products, but the problem is delivery. How will supply chain disruptions affect private equity  in 2022?

We’ve written a special Lead Left series on this issue. During covid, sponsors worked hard to reduce supply chain inefficiencies that had always been there, but were exposed by the pandemic. As Omicron demonstrated, if workers get sick again, stuff doesn’t get done. Store shelves are bare again, reminiscent of 2020. It’s a daily battle, but sponsors now have the playbook.

What trends are you seeing in valuations? What kinds of returns are private equity investors getting for exits in today’s market?

We just held an exclusive Lead Left Presents webinar on M&A trends. Valuations are at record highs, thanks to dry powder and thirst for good assets. But that’s been the case for five years or more. Auctions today are all about buyers finding an angle to distinguish them as the most attractive partner for the seller. Returns are driven by the success of that strategy and by finding add-ons at lower multiples to reduce the effective price of the asset.

What about hold times, are they shorter, longer or the same as they were pre-covid?

Our friends at Pitchbook report that median hold times for PE buyouts is about 5 years – a period that hasn’t changed much since 2015. Yes, high valuations encourage early exits, but then you have to re-deploy the money…at even higher multiples! And sponsors are increasingly using continuation funds that provide for further investments in existing portfolio companies.

What keeps you up at night? And what are you excited about in 2022?

The first and foremost concern is credit quality. Any portfolio deterioration hurts alpha in a direct lending strategy. But our long experience and defensive sector posture has translated to no losses or defaults through the pandemic. The other focus is retaining and attracting talent. We’ve doubled the size of the firm since covid began. It’s a real challenge keeping our great culture fertilized in a Zoom environment. But watching our amazingly gifted and hard-working professionals hit their stride as we eventually return to the office is the most anticipated event for 2022.

For more PE Hub Q&As, see our interviews with Pam Hendrickson, vice-chairman of The Riverside Company; Trevor Clark, founder and managing partner of Twin Brook Capital Partners; and Zia Uddin, president, Monroe Capital.