Private equity exit activity hampered by uncertain economic climate
- Volume of exits drops to 61 in 2012 from 85 in 2011
- 80% of companies increased value under PE ownership
London, 24 June 2013 – Private equity (PE) exit numbers dropped in Europe last year to 61 from 2011’s total of 85 according to Myths and challenges – How do private equity investors create value?, Ernst & Young’s annual study of European PE exits. The report cites a volatile economic climate and low transactions activity as the primary challenges for PE.
However, despite the criticism sometimes leveled at the industry, in aggregate terms PE-owned businesses grew employment by 2% in 2012. Forty-four percent of the businesses studied made adds-on acquisitions, while only 10% made disposal. Eighty percent delivered gross returns to investors above leverage and market returns from 2005 to 2012.
Sachin Date, Europe, Ernst & Young‘s Middle East, India and Africa Private Equity Leader says: “With Europe and many other regions showing little or no GDP growth over such a prolonged period, the PE portfolio has inevitably been affected. Profits growth in businesses exited in the boom times was running at over 15% a year; the figure for businesses exited in the last two years has fallen to 5% – demonstrating that driving growth in the portfolio has become very difficult indeed. Ultimately, the knock-on effects of this trend lead to some stress in the industry as investment returns decline, investors become selective, and some firms struggle to raise a new fund.”
Leonid Saveliev, Ernst & Young‘s Partner, Russia adds: "In Russia PE houses struggle to source quality entries despite the fact that a number of companies are seeking to attract financial investors. The reasons include both low quality of assets and somewhat cautious behavior of investors driven by overall uncertainty as well as industry-specific reasons, such as negative impact of Russia's WTO accession on agriculture business.
A number of assets available for investment represent "traditional" industries, such as metals and mining and the related industries which in many cases represent little interest to PE houses."
Low PE activity levels
Since the onset of the crisis, the PE industry has seen low levels of activity relative to the size of the portfolio. The decline in exits in 2012 was even more significant; there were only 61 exits in our 2012 sample, down from the 85 exits in 2011 and almost on par with 2010 levels. While the proportion of trade buyers increased, only 9 of the 24 exits that went to trade were bought by European companies; 10 were sold to US buyers and 5 to strategic buyers from Asia Pacific and the rest of the world.
“At under 40% of exits to European trade buyers, this is the lowest percentage ever recorded in our study, a clear demonstration of the lack of confidence European corporates experienced in pursuing M&A strategies. On the flip side, the proportion of trade exits that went to US and buyers from the rest of the world increased in 2012. This is just one sign that international buyers are an important source of exits for PE, while European buyers continue to hold back,” says Date.
In contrast with 2010 and 2011– when sales to other PE houses accounted for nearly half of exits – secondary buyouts reduced in 2012 as a proportion of exits to just over 35%. After a fall in number in 2011, creditor exits increased in 2012 as the prolonged downturn took its toll on some businesses in the portfolio.
Investment in some areas
By investment, some areas are more active than others. The €150m to €500m entry enterprise value (EV) bracket grew its portfolio by 27% between 2007 and 2012. However, when moving up the investment size spectrum, growth in the portfolio reduces. Investments with an entry EV of between €500m and €1b grew by 11% in the same period, but the two brackets above – €1b to €2b and over €2b – recorded declines of 4% and 13% respectively . And it is these parts of the market have been hardest hit.
Harry Nicholson, Ernst & Young’s PE partner comments: “While most acute in the over €2b investments, across the portfolio the low level of exits presents a challenge for PE. Making new investments is obviously important, but PE will need to increase its focus on realizing the backlog of companies to be exited to return capital to investors. Exit rates need to increase two to four fold over the coming few years if this overhang is to be is managed successfully. In today’s M&A market, the bar has been raised in terms of completing exits. PE still has more to do to ready their businesses for sale, widen the buyer pool and create competitive tension”.
Nevertheless, low exit activity should not be interpreted as an indicator of the PE portfolio’s overall health. Analysis of companies in the portfolio shows there is value to be generated if PE can find ways of selling businesses. While according to the data, 20% may generate a less than 1x equity return; over 40% are expected to achieve investment returns of at least 2x equity invested.
80% of exited portfolio companies increased their value under PE ownership
While the industry will continue to face difficult challenges, the study signals that PE’s focus on absolute value growth through investing capital and hands-on involvement in its portfolio companies does create better and more valuable businesses.
Over a third of PE-backed businesses in our sample doubled entry EV by the time they came to exit. The study shows that nearly half of all exits in the sample grew 100-200% over their entry EV while 34% of the sample grew more than 200%.
Although 19% of the businesses in the study were less valuable at exit, the vast majority of PE-backed businesses were clearly more valuable at exit than they were when acquired. Annual EBITDA growth in these businesses also continued to outpace public company benchmarks – even those businesses that came through the recession and were exited between 2010 and 2012.
Says Nicholson: “The objective of PE investments is to see growth in business value. The data shows that in aggregate PE is successful in this, and value growth is achieved in the majority of investments by productivity growth, employment growth and investment."
Date concludes: “As we move through 2013, it is unlikely that the market will be there to help with the challenges that the PE industry faces. The IPO window cannot be relied on and European corporate buyers remain uncertain. PE needs to beat the wider M&A market by stimulating strategic interest from trade buyers, particularly those outside Europe. Generating successful exits will be the key to securing future funding from investors, who can only be patient for so long. However, the data shows that the PE model remains resilient despite the challenges it faces.”
About the report
The 2012 study of Myths and challenges – How do private equity investors create value? provides insight into the performance and methods of PE, based on the analysis of the largest European businesses that PE has exited over the last eight years. The owners of these businesses were not all European-based themselves; this is not a study of the performance of European-based PE investors, but is rather an analysis of the impact of PE on European businesses.
To avoid performance bias, and to ensure a focus on the largest businesses owned by PE, exits were screened to capture only those that had an EV at entry of more that €150m. This criterion was also applied to our estimate of the current size of the PE portfolio. In total, we have identified 527 exits of businesses that met our criteria over the eight years from 2005 through 2012 — the “sample”.
We assessed business performance for the duration of PE ownership — i.e., from entry to exit — based on key performance measures, including change in EV, profit (defined throughout this report as earnings before interest, tax, depreciation and amortization, or EBITDA), employment, productivity (defined as EBITDA divided by number of employees) and valuation multiple. To better measure aggregate economic impact, we used weighted averages.
This independent study is built with public data across the whole sample and detailed, confidential interviews with former PE owners of these businesses. Overall, we have performance data for up to 383 businesses or 73% of the total population. Looking across key performance dimensions (e.g., deal size, exit route, incidence of creditor exits), there is no discernible bias in the composition of the sample compared with the whole population. For some of the performance metrics, our sample size is smaller than 383, and there is no significant bias compared to the whole population as measured by EV growth.
EV growth for the different sub-samples in this study
EV Performance measure
Relative returns and portfolio growth by sector, 2005–2012
PE returns compared to the market; Returns from PE relative to stock markets, by entry EV range
Productivity and employment growth for PE-backed companies
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