Private equity exit strategies are changing in a resilient yet volatile marketplace

PE firms focus on exit value and speed while deal conditions are favorable, as market volatility picks up and sector convergence continues.

Despite uncertainty from tariffs, a trade war, desynchronized growth and geopolitical concerns, the market offers sellers a resilient yet competitive environment. PE firms continue to be active sellers, exiting businesses that have hit performance targets and responding to opportunistic approaches. They are scrutinizing hold periods and divestment strategies to avoid missing out on attractive valuations.

According to the EY Global Private Equity Divestment Study, market data underlines the message that a heated PE exit environment has shifted to a normalized but brisk pace, with volumes leveling off. In 2018, PE firms made 1,175 exits globally, slightly above the total volume of 1,149 exits seen in 2017 — down from a peak in 2014. Deal values remained strong in 2018, hitting US$385.2b and on par with US$385.8b in 2017.

At the same time, IPOs have seen increasing interest. Fourteen percent of firms say their last major divestment involved taking an asset public, up from 2% the year before. Perhaps most significantly, 27% expect their exits to IPO in the next 18–24 months.

What will influence the next wave of exits?

Over the past 12 months, PE has taken a pragmatic approach to exits: 41% say their last divestment was triggered primarily by a business achieving its EBITDA goals, while 20% say it was driven by a portfolio company’s weak competitive position. But other market forces are at work, potentially influencing the next wave of exits.

More than half (54%) of PEs believe geopolitical uncertainty and macroeconomic volatility will affect exit decisions in the next 12 months. Cross-border trade agreements, Brexit, non-tariff barriers and tax policy changes such as the incoming OECD/G20 Base erosion and profit shifting (BEPS) project will all factor into decisions.

Eighty-two percent of firms expect these geopolitical shifts to push operational costs higher. This will require PEs to factor these rising costs into their divestment strategy and timing.

At the same time, the majority of firms (59%) are anticipating the impact of sector convergence on their portfolios. Technological advances are driving the need to redefine business strategies and the capital investments required to support technology for future growth in their portfolio companies.

PEs say opportunism will continue to influence divestments, with 74% ready to jump at unsolicited bids. This underscores the importance of preparing businesses for sale early to maximize exit value and speed in an unplanned divestment scenario.

Overall, few PEs (23%) say they expect a reduction in multiples in the next 12 months, but the majority (78%) say they are prepared to exit portfolio businesses quickly in the event of a market correction over that same period.

How are exit strategies changing?

This year’s survey suggests a change in emphasis for many PE firms. When acquiring businesses, their top two exit considerations are the company’s market position (54%) and the potential exit timing (36%). During this extended period of competitive valuations, buyers have shifted focus away from organic growth potential (16%), a top priority a year ago for 43% of PE firms.

While exit timing is a key consideration right from the point of acquisition, 42% say they determine the right time to sell one-year pre-sale, down from 61% last year. Instead, a growing number (38%, up from 21% last year), say their exit timing is becoming more opportunistic.

Against this backdrop, PE firms are primarily working with portfolio businesses to reshape strategy and create value during their period of ownership. More than half (58%) say strategy is the area where they get most involved with their portfolio companies, followed by M&A (42%), well ahead of any other areas.

Where are the value creation opportunities?

PE firms tend to be hands-on owners, with 81% reporting they interact, at minimum, monthly with portfolio companies to drive value. And while cost reduction and improvements to working capital top the list of value creation strategies, PE firms are also actively involved with helping companies plan for channel expansion, making changes to products and service offerings and bolt-on acquisitions.

However, there are other areas where PE might be leaving money on the table. Most notably, while 62% of PEs say digitalization of the business was an important element of the value story in their last divestment, only 11% cite digital enhancements as the most important element of their portfolio companies’ strategy.

In other areas, PE clearly applies their experience as owners of many businesses — 78% say innovation is one of the most important elements of their companies’ business strategies, reflecting PE’s determination to help portfolio companies drive sustainable growth.

However, PE firms will need to show buyers that their value creation plans have been implemented if they expect to achieve their anticipated returns.

How are analytics helping to improve exit outcomes?

Data and analytics can drive better outcomes at every stage of the private equity value chain, from management of portfolio companies to better decision-making at exit. But this requires investment both in technology and talent.

Analytics at the fund level

PE firms are using analytics tools to uncover critical insights on both the way into and out of portfolio investments. While most (87%) of firms say they used analytics to make their latest exit decision, they also point out that most value was created during the diligence process prior to acquisition and in pre-sale preparation at exit.

But many are still working through this process: applying data-driven analytics consistently in their portfolio reviews is still a significant issue for 80% of PE firms — up from 64% last year.

Data standardization is also a challenge for PE firms — working with dozens or even hundreds of portfolio companies across multiple industries, each with their own KPIs and reporting protocols, makes it difficult to get an overall view. However, firms have made progress — 75% of PEs now have access to portfolio management tools that enable them to standardize reporting across the portfolio, while two-thirds (66%) use technology that gives them real-time access to management performance.

At the portfolio company level

How can firms use data and analytics to drive EBITDA and growth to position an asset for sale? And how can analytics help sellers present the value story to buyers?

Many firms are improving their use of data, but with tacit acknowledgement that there is room for improvement. Less than a third (30%) say they are very effectively managing portfolio businesses real-time and capitalizing on customer and margin opportunities. Less than a quarter (22%) are very effective at using data tools to position and validate their businesses for potential buyers. For example, social media analytics can be applied to transaction scenarios to uncover and anticipate trends throughout the portfolio. “Social listening” — where data from social media channels are captured and reviewed — can monitor customer buying patterns and preferences, as well as spotting and rectifying reputational risks and customer complaints before they get out of hand.

Giving potential buyers access to portfolio business data makes a big impression. According to 66% of PE firms, providing more detailed information — including the outputs from advanced analytics exercises such as stress testing and predictive modelling — can help underpin the valuation and provide an evidence-based value story during an exit. Sales volumes, customer churn and pipeline are important, but items like customer service and satisfaction — key indicators of both vulnerabilities and success — should also be on management’s radar.

Conclusion 

The market continues to offer opportunities to trade assets at attractive valuations, with PEs looking to take a more opportunistic approach to divestments.

However, to maximize value, PE firms will need to be prepared to move quickly when these opportunities present themselves. They also need to be adaptable, as they expect a shift in buyers — including more strategics — competing for their assets.

PE firms are building up their exit playbooks, with more discipline and rigor in the portfolio review process to prepare for their next wave of exits.

In building, executing and monitoring more wide-ranging value creation strategies for each asset, PEs can articulate a detailed value story to buyers.

Analytics is providing a huge opportunity for PE firms, with many only just beginning to tap its potential. Analytics tools provide a way to make more informed decisions throughout the exit life cycle, from identifying long-term growth strategies for portfolio businesses to securing greater divestment value.