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A renewed appetite for private equity investors - Private equity future outlook - EY - United States

A renewed appetite for private equity investors (North American study)

Private equity future outlook

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In the face of a tougher exit environment, PE will be challenged to increase its exit activity to achieve a more "normal" level of sales.

Summary: Looking ahead, the improved environment for exits that started in 2010, and continued into the first half of 2011, appears to have slowed. Exits via IPO, in particular, saw a substantial rise through the second quarter of 2011.

Private equity investors face uncertain exit activity

While the pipeline for PE-backed IPOs is still strong, with a number of large PE-backed companies filing to go public in the US over the remainder of 2011, public markets remain volatile — leaving it an uncertain exit route for PE investors. Once again in the face of a tougher exit environment, PE will be challenged to increase its exit activity to achieve a more "normal" level of sales.

There is a large part of the PE story that has yet to unfold. The number of companies in PE's portfolio continues to expand and in 2010, in the US, reached a record level of approximately 6,0002, including a large component of deals completed during the boom years of 2005-07. The inevitable result, as our analysis finds, is a continued increase in holding periods.

Holding periods for deals increase

The average holding period for deals exited in 2010, at 4.4 years, was the longest since our study began in 2006. A shortage of activity by corporates both in the US and Europe – which remain largely out of the M&A markets — will continue to impact exit activity levels. Trade buyers have historically provided the most significant exit routes for PE and, until they return to the market with more consistency, exit figures will be muted.

The industry is also under pressure to return capital to LPs, especially those looking to raise new funds in the next 12 to 18 months. But LPs are not just seeking crystallized returns from the funds they will back in the future. They remain highly selective and are seeking to rationalize the number of GP relationships they maintain.

As a result, they have become more focused on conducting extensive due diligence and are increasingly seeking to understand how PE firms add value. LPs are also increasingly wary of secondary buyouts as they become more prevalent, once again.

However, as our research highlights, PE is increasingly focusing on operational improvements in the businesses it backs, regardless of how the deal was sourced, to generate strong returns from secondary buyout deals, as from other types of transactions.

An increasing focus on operational improvements

Those able to demonstrate a consistent track record in creating value in their portfolio that translates into best-in-class realized returns, should be well positioned to attract fresh capital. PE, similar to other industries, is not immune to continued macro-economic uncertainties, including the impacts of the US and European sovereign debt issues that cloud the horizon.

And growth in many developed economies will likely be subdued for a number of years to come.However, as our research demonstrates, PE is resilient, nimble and has demonstrated an ability to withstand shocks. It has taken on board valuable lessons and has regrouped following the crisis.

PE will once again have an opportunity to prove that its active ownership — as we have found in both the North American and European studies — enables it to create stronger and more profitable businesses.

This is despite difficult times; by driving operational improvements and growth in the companies it backs, the industry delivers solid returns that outperform public market benchmarks. This confers benefits not only on the companies themselves, the PE houses and their investors, but also on the economy as a whole by creating sustainable, well-managed and growing businesses.

2Source: Pitchbook

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