Our analysis reveals that PE is able to create enduring value in the companies it backs and consistently outperforms public companies in key value drivers.
Private deals show highest returns
This year, we analyzed the performance profile of the four main sources of deals over the 2006–10 period. Returns from buying a privately-owned business performed the best of the four categories when creditor exits are included. This is in contrast to take-private deals — where companies are de-listed — which under-performed.
Our study also found that, despite limited partners' (LPs) apparent disquiet about the prevalence of secondaries — where PEs buy from other PEs, these deals provided the second-best returns over the full five-year period, despite a decline from the highs of 2006–07. This outcome includes creditor exits contained in our sample.
In many cases, secondaries have produced higher-than-average returns, demonstrating there can still be significant value created during subsequent PE ownership.
Value creation at the heart of PE outperformance
Our studies, which now span a five-year period, have shown that PE is able to create enduring value in the companies it backs, and that it consistently outperforms public companies in key value drivers — EBITDA growth, employment growth and productivity.
Consistent with our European study, our returns analysis shows that PE strategic and operational improvement drove most of the value created in PE portfolios over the long and short term.
For the 2006–10 period, this accounted for 57% of PE returns over the five years, while stock market return was responsible for less than 1%, and additional leverage (over public company benchmarks) for just over 40%.
This is consistent through good times and bad, and even where other sources of returns, such as stock market returns, are negative. PE's returns continue to be driven by its ability to effect change in the companies it backs in a private setting.
Organic revenue growth and cost reductions: largest sources of EBITDA growth
Our analysis shows that operational improvement remains the most important driver of PE's value creation, rather than multiple expansion and additional leverage, consistent with the findings in our European study.
However, our study also shows that this component has increased in importance compared with pre-crisis years. This is, in part, a reflection of the fact that it is more difficult to generate returns through multiple expansion and leverage in low growth economic cycles.
It also provides evidence of PE's increased focus on improving operations of these businesses. In this year's study, we sought to determine how PE achieved EBITDA growth during the holding period. Over the longer term, revenue growth was the most important source, accounting for over 40%.
EBITDA growth attribution by investment rationale, 2006–10
Cost reductions were responsible for approximately 30% of EBITDA growth, and add-on acquisitions became a more significant component, representing about 20% of growth. PE's ability to use every available lever to enhance the operations and growth prospects of its portfolio companies was clearly vital to their success during times of economic stress.
Private equity strategies that enable EBITDA growth
PE used all methods to achieve growth through one of the toughest recessions in history — focusing on organic revenue growth and cost reductions with equal emphasis. Our study shows that PE stayed close to its portfolio during the downturn, flexing strategy as necessary.
PE was able to spot good growth opportunities and benefit from growth in market demand — much of this in non‑cyclical and counter‑cyclical industries. However, changing business models or strategies drove over half of organic revenue growth. And, as in Europe, these factors accounted for more organic revenue growth than the functional changes made to pricing and selling initiatives.
Geographical expansion has played a particularly important role. The superior growth opportunities in emerging markets, particularly as developed economies have stalled, provided a further lever for PE to add value: by assisting portfolio companies in expanding in these markets to exploit the growth opportunity, particularly in India and China.
For example, our research uncovered evidence of PE using its networks to open the right doors for businesses looking to expand into emerging markets, but lacking the contact base and local know-how. PE is helping to de-risk the process of capitalizing on the opportunities available in new markets.
Drivers of organic revenue EBITDA growth, PE exits, 2007–2010
Fundamental changes yield results
As the recession continued to persist in North America, cost reductions and restructuring played an increasing role in delivering growth. Operational efficiencies and improvements in procurement practices combined for nearly 70% of EBITDA growth from cost reductions and restructuring.
PE is digging far deeper into every aspect of a company's operations. These fundamental changes — while difficult to achieve — clearly have the greatest impact on profit growth and have yielded better results for both PE and the businesses it backs.
There is also growing sentiment that achieving efficiencies in these businesses can be leveraged across the portfolio, providing additional growth opportunities for all businesses in the PE stable.
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