Private equity investors drive sustainable improvements in the businesses they back, generating not only financial, but also social returns.
Each year, we research the latest exits by PE houses to analyze the performance of businesses during PE ownership on the basis of the financial returns from the original investment. Through our analysis, we seek to understand and explain if and how PE adds value to the businesses it backs.
Private equity weathers the economic storm
This is the latest of our annual studies looking at if and how private equity (PE) investors create value. Since we started this project in 2005, we have used a consistent set of criteria to select our study group: European-based businesses owned by PE, with enterprise value (EV) of more than €150m at the time of PE investment.
Our seventh study is set in a time of continued macroeconomic uncertainty across Europe. The sovereign debt crisis has cast a long shadow across the region's economies and companies. Yet despite that, the industry continues to weather the economic storm.
Exit numbers improved significantly in 2011 as PE owners seized opportunities to realize investments. And, over the last seven years, our research has shown that 87% of realized investments generated a positive return for investors, and in 2011 this figure was 90%.
PE owners continue to seize opportunities
Exits rose to 83 in 2011, the highest number recorded since the peak years of 2007 and 2006. Most notably, trade buyers, who had been noticeably absent in recent years, returned in 2011 — and accounted for most of the growth in realization volumes.
Our analysis shows that the gross return on these PE investments outperformed investments in comparable public companies by a factor of 3.6 times. Proactive strategies employed by PE owners to build the value of their businesses (PE value creation) rather than additional leverage, accounts for the majority of this outperformance.
Returns from PE relative to the stock markets, by entry EV range, 2005–2011
N = 307 (excludes deals for which insufficient data are available to calculate returns)
Source: Ernst & Young data, DataStream
How is PE creating value?
Part of the PE value creation came from driving business improvements in its portfolio companies, evidenced by strong productivity growth. It also came from carefully selecting, and backing, the businesses and management teams that had the greatest potential to produce a step change in value.
In this year's study, we analyzed PE's realized investments across different markets in Europe, to determine whether its track record across different deal sizes, types, geographies and sectors, might help guide future investment. The simple finding is that the PE model works across all the different markets and deal types in our analysis, with returns well in excess of those achieved by comparable public companies.
The PE model works for all markets and deal sizes
Our study shows that the PE model works across all deal sizes, with those between €150m and €500m in entry EV showing higher PE value creation (or PE strategic and operational improvement) than larger deals.
In our geographic analysis, we demonstrate that PE has adapted to the different markets across Europe, with the UK and Ireland, France and the Germany — Switzerland — Austria (GSA) region emerging as particularly strong markets in terms of productivity growth. Looking forward, the French and GSA PE markets also show potential for high growth given that their PE penetration rates are low relative to other regions, such as the UK and the US.
By industry sector, capital- and consumer-led sectors, such as personal and household goods, saw below-average performance and growth — in line with lower returns from public companies in the sector. Business services, retail and health care emerge from our study as the best performing and largest sectors for PE.
Improving health continues for PE
The overall picture that emerges from our study is one of improving health for PE as exit activity grows, creditor exits fall, and PE investments continue to deliver outperformance relative to public markets.
And, while the patterns of returns, outperformance and productivity growth have varied across different markets analyzed in this report, the overall conclusion is that the PE model has had widespread success.
Selecting investments and driving business improvements have been key to successful PE investment. If they are to continue generating high returns at a time of low economic growth across the region, PE firms will need to hone these skills further.