European PE assets show continued growth, despite challenging times
London, 14 September 2009 – The largest businesses across Europe exited by private equity (PE) investors in 2008, achieved impressive growth under PE ownership, according to the fourth annual PE study by Ernst & Young, and showed growth rates consistent with the prior three years of research.
Challenges in a new world – how do private equity investors create value?, (pdf, 2.8mb) an analysis of nearly 300 of the largest European businesses owned and exited by PE over the last four years, finds that from acquisition to exit there was on average 15% annual growth in profits, as well as employment growth of 5% and productivity growth of 9%. Furthermore, the average performance of PE-owned businesses was ahead of public company benchmarks, even after adjusting for leverage.
John Harley, global private equity leader at Ernst & Young, says:
“By selectively applying its distinct ownership model and targeted business improvement initiatives PE has been able to achieve above market returns; indeed the top portfolio companies have achieved a considerable advantage over their peers.”
The findings also show that PE has remained committed to its poorer performing businesses. The average period of PE ownership for troubled investments was seven years, twice the hold period of other investments, with 43% having experienced a change in top management and 36% received further equity injections.
Harley continues: “While there have been some businesses that fell short of minimum returns, there has been no evidence of short-term behavior towards troubled investments as PE investors and management worked hard to change strategies and implement new actions to improve profits and cash flow within these companies.”
Decline in exits
In 2008, compared to 2007, it comes as little surprise that the volume of PE exits fell by 66%, from 89 to 30 exits and total entry enterprise value (EV) declined from circa €54bn to some €12bn (77%).
Harry Nicholson, private equity partner at Ernst & Young LLP, says:
“The decline in the number and value of exits reflected the challenging macro-economic environment, while the drop in exit value can be partly attributed to the difficulty in raising debt as well as the absence of IPOs in 2008. IPOs have typically accounted for 10-15% of exits and are a critical exit route for the largest PE-owned businesses. This has led to a large number of €1b+ companies in portfolios still to exit and poses a real challenge for the industry in the next few years.”
Without a single IPO exit by PE in 2008 across Europe, and corporates accounting for only 26% of buyers, new PE investors were the main exit route, accounting for 74% of buyers in 2008, despite the tightening credit markets, up 50% compared to 2005.
“Interestingly however, the secondary buy-out deals performed just as well as the primary deals, with growth and operational efficiency opportunities exploited just as frequently”, continues Nicholson.
The waiting game
The reduced number of exits in 2008 seen alongside the average high returns that those exits achieved reinforces the view that PE houses sold strong businesses in 2008. If they were not certain of a high return, they held on to the asset. While so far PE had held on to “troubled assets”, there is likely to be increasing pressure to reduce portfolio holdings in order to return cash to investors and make new investments.
“The growing economic pressure in 2009 will likely see a decline in rates of profit and job growth. We can foresee PE choosing to step back from some of these troubled investments, and to seek exit opportunities for them, particularly in funds that have strong, if not already guaranteed, returns”, says Harley. “While there were no exits by bankruptcy in our study in 2008, the continuing economic decline in 2009 has already changed this position and they are likely to increase further this year.”
Financing the future
Harley concludes: “We are already seeing signs of markets and financing improving in some areas and a pipeline of PE-backed IPOs. However, debt is unlikely to be available at the levels of recent years. The reality is that if the PE industry does not exit existing investments or create strong cash flows to reduce debt levels, it will have trouble refinancing a significant amount of the debt used to acquire these businesses, much of which matures in 2011-12.
“The large number of assets worth over €1b+ means PE will be looking more than ever at understanding the drivers of performance improvement that are most relevant to their portfolio companies. These insights are likely to be the key drivers of success as PE prepares its businesses to take advantage of a reawakening IPO market and focuses on “exit readiness” for companies in its portfolios.”
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