In 2021, private equity funds used bundles of debt to buy 786 food and beverage manufacturers worth $32 billion. But higher labor costs, supply chain disruption, and inflation changed the outlook for what seemed like a stable industry. As consumers have altered their shopping habits in the face of rising grocery prices–buying less or choosing cheaper products–PE firms are feeling the squeeze.
The firms want to maximize profits but not raise prices such that they lose market share to companies with smaller price increases, according to The Wall Street Journal. When PE firms went on a shopping spree of leveraged buyouts in 2021, they used some of their own cash but mostly borrowed money from the companies they were to purchase. The acquired companies would have to pay large annual interest rates on the loans, which is doable when the economy is stable. But when it isn’t, and when interest rates increase, the picture rapidly changes.
Typically, The Journal reports, such loans float, or fluctuate up or down with the Federal Reserve’s interest rates. The rates generally drop when economists fear a recession. But the Fed has continued to raise rates even as fears of a recession linger.
To boost profits at their acquired companies, PE first often increase prices, which also helps cover the cost of debt and sometimes enriches the firms.
In a solid economic climate, buyouts can generate returns above 20%, but in 2022, PE firms lost an average of 9% through September, according to McKinsey & Co. data. “Multiple headwinds struck at the same time and they would be less pronounced if not for a combination of factors that often lead back to private equity,” Christina Padgett, an Associate Managing Director at credit-ratings firm Moody’s Investors Service, told The Journal.