Apollo's co-president warns: Private equity is "losing its way", valuation correction is "inevitable"

Scott Kleinman, co-president of Apollo Global Management Inc., warned that in the era of loose monetary policy, private equity has "lost its way a little." As borrowing costs normalize, related institutions "will inevitably have to make concessions on valuation issues." In an interview on Wednesday, Kleinman said that some fund management companies have made errors in their timing of investments, and in the future either will be forced to reduce fundraising size or "exit the market." He pointed out that especially funds raised between 2017 and 2022 have run into difficulties because they paid too high prices in transactions, which in turn dragged down internal rates of return a key measure of industry profitability. He noted that the industry's business model has undergone a fundamental change: from the early days of "finding quality assets, paying reasonable prices, optimizing operations" to a more aggressive approach of "finding good assets, and then not messing it up." "When interest rates fell to zero and remained there for ten years, the price paid for acquisitions 'didn't really matter' because in a zero interest rate environment, valuations would just keep going up," Kleinman said. However, the substantial interest rate hikes implemented to combat inflation have "changed everything." Two years ago, Kleinman likened the return of private equity to a point where it was difficult to return to previous levels until "the pig goes through the python," indicating that the industry was facing a large number of difficult exit projects. He said in an interview during the SuperReturn conference in Berlin that private equity firms are now furthering this "digestion" process. "The inventory of companies held by private equity is really, really high," he said. "It's very difficult to exit these companies at the prices that institutions broadly want." Private market managers had hoped to start clearing the backlog of long-overdue exits from invested companies this year because falling interest rates and strong economic prospects had boosted expectations for merger transactions. However, reality has gone against expectations: concerns about artificial intelligence impacting the software industry, pressure to return capital to investors, doubts in the retail market about loan valuations, and multiple factors such as the Iran war have dealt a heavy blow to the industry. Nevertheless, Kleinman also pointed out that the current environment for new investments is positive due to the still strong economy and reasonable valuations. Despite the huge pressure on exits, he remains relatively positive about the current environment for new investments. He noted that the U.S. economy remains strong and asset valuations are at reasonable levels, providing favorable conditions for new investment projects. In other words, the private equity industry is facing a "two-tiered" scenario: difficulty in exiting existing assets and pressure for valuation adjustments, but the cost-effectiveness of incremental investments is improving. Kleinman's remarks send a clear signal that the valuation expansion cycle of the private equity industry that has lasted for more than a decade may have come to an end. Fund managers who bought in at high levels, relied on leverage and multiple expansions to achieve returns will be forced to face reality either lower valuation expectations to complete exits, or face capital depletion and be forced to exit. For investors, this means that the return differentiation in the private equity market in the coming years will significantly intensify. Only institutions that can accurately grasp the timing of exits and have genuine operational value-added capabilities have a chance to succeed in the new interest rate environment.