We talked to a dozen experts to find out what less consumer spending in the wake of the Covid-19 pandemic means for private equity.

In recent months, as the Covid-19 pandemic has slowly receded in the United States, experts in the private equity world have been closely watching consumer spending habits. What they’ve seen is a shift towards frugality that is likely to have a profound impact on the industry in the months and years to come.

“Instead of eating that steak, they’re going to the QSR,” said Brent White, Vice President at Gauge Capital, a Dallas-based private equity firm focused on investing in growth-oriented middle market companies. “What they’re trying to do is downsize what they buy and be more frugal on how they spend their money.”

White says the ripple effects of this new frugality are already being felt in the private equity world, where the deal flow has slowed, and valuations have come back down to earth. “We’re not going to see the elevated multiples. We’re going to see normalized multiples and valuation expectations for these businesses,” he said.

White is not the only one seeing this shift. Across the private equity landscape, experts are predicting a “less liquid” quarter ahead, as businesses that were once seen as sure bets become less attractive to investors.

“I do believe that there will be a slowdown,” said Bobby Sheth, Managing Director at Salt Creek Capital, a private equity firm based in Woodside, California, adding that he does not expect to see a recession like the one that followed the financial crisis of 2008.

“As we think about mass-market chains and products that are much more commoditized in nature, we think that there’s going to be a bit of a slowdown over the next three to six months for sure,” he added.

But Sheth added that specialized higher-end businesses such as certain wine racking service providers and wood flooring companies that he has invested in over the past year are likely to weather the storm better than their mass-market counterparts. As these businesses offer more experiential products and services that consumers are willing to pay a premium for and can be seen as a real asset that counters inflation.

The Russia-Ukraine conflict and its broader geopolitical implications on oil prices are among the other factors that could have an impact on consumer spending and, as a result, private equity in the months ahead.

“That’s probably what keeps me up the most,” said Sheth, “if that escalates, if that keeps on getting worse, what does that mean? I think broadly, and I saw this, again, kind of in 2008 and 2009, you know, if oil stays at elevated levels for a significant period, that causes all sorts of ripple effects across the economy.”

The new shift toward frugality is at odds with the first quarter of 2020, when consumer spending was 24% higher than pre-pandemic levels, according to a Bank of America study. But as inflation and gas prices rose and the government stimulus checks dried up,

consumers appear to have tightened their belts.

“People took a pause and started being cautious about where they spend their money,” said White. “And you’re seeing that flow through the balance sheet on a lot of these companies that we review that are coming to market.”

David Thibodeau, Managing Director, Wellvest Capital, a Boston-based firm investing and advising companies that are in the consumer health and wellness space, argues that further price increases could lead to an even more pronounced shift in consumer behavior.

“Many of our portfolio companies/clients have been taking price increases over the last year and multiple price increases,” he said.

“Not just one or two, but multiple. That’s going to reach a limit. The consumer is going to, at some point, start to say ‘no, we’re just not willing to [accept that]. I think we’re already we already seen that in some of the IRI numbers where people are moving towards replacement brand replacement products to brands,” he added.

Ketan Mehta, Managing Partner at The Corporate Development Group, a California-based investment bank that specializes in consumer products, remains optimistic, however, arguing that in the long term, the pandemic will lead to a pent-up demand for consumer goods and services.

“But I think we’re gonna have a soft landing,” Mehta said, predicting the supply chain issues that have plagued businesses in the past couple of years will eventually ease next year “We may dip into recession, a very short amount of time, maybe towards the end of this year or first quarter of next year. But I think 2023 is going to be an OK year.”

Similarly, Nick Barker, Partner at Longhouse Partners, a Detroit-based consumer-focused private equity firm, is bullish when it comes to the merger and acquisition market (M&A) for consumer businesses.

“Because of consumer demand, a lot of businesses are now, of course, trying to sell off of those arguably inflated earnings, and people are buying off of those inflated earnings,” he said.

“But I think we’ve seen several data points where that level of aggressiveness in the M&A market is persisting. I think everyone’s obviously kind of thinking about recession and what that may mean. So, there may be a little bit lower leverage applied to some of these deals and more and more equity, but we haven’t yet seen that have a massive impact on overall valuations,” he added.