Rise of supply chain and inflationary pressures – challenges and opportunities for private equity in 2022

Ropes & Gray private equity partners Carolyn Vardi, Tsuyoshi Imai and I, alongside finance partner Jay Kim and restructuring partner Ryan Preston Dahl, have explored – in this article – the challenges and opportunities for private equity caused by the rise of supply chain and inflationary pressures.

Shortages and breaks in the supply chain

As well placed as PE is moving into 2022, investors are aware of the risks posed by shortages of key commodities and energy, as well as ongoing strains on global supply chains. Distribution chains and supplies of key goods and services came under increasing pressure in 2021 as economies rebooted post-lockdown and demand skyrocketed. This is a global issue and if supply chain pressures persist, PE firms will see sustained impact on the performance of their portfolio companies. Deeper diligence of supply chains has also emerged as a theme in global markets and, in some cases, risks have been so acute that deals have stalled due to supply chain issues.

However, amid supply chain pressures, there are also opportunities. Firms with large portfolios have been able to support companies and add value by leveraging portfolio scale to lock in supplies and keep a lid on rising costs.

On the investment side, opportunities to reengineer and near-shore supply chains are emerging, as are options to invest in exit logistics and distribution assets, many of which have strong technology angles.

Rising prices, inflationary pressures and interest rates

Rising inflation has been a direct consequence of the global supply chain bottlenecks in 2021. In the US, inflation has reached 30-year highs, European inflation has climbed to its highest level since the introduction of the Euro and prices in China are climbing into the double digits.

For PE firms, the jury is still out on how long inflation will persist, but managers are nevertheless building higher inflation into their scenario planning and portfolio management.

In addition to the direct consequences of inflation on portfolio and target company profitability, rising inflation and its role as a spur for interest rate hikes could also have an impact on PE portfolio company capital structures. Low interest rates have given companies a degree of breathing room to deleverage, post-pandemic panic, with minimal disruption. However, should rates rise, capital structures that were sustainable in a low-rate environment could start to dip underwater—especially in levered PE-backed companies.

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