5 minute read 1 May 2019
woman presenting ideas team

PE Pulse: how PE firms are avoiding the worst of today’s high-price environment

By

Andres Saenz

EY Global Private Equity Leader

Trusted advisor to leading private equity professionals and their portfolio companies. Ardent student of consumer behavior. Marathoner. Family man.

5 minute read 1 May 2019

PE firms are seeking ways to remain active while mitigating continued high valuations.

2018 represented the strongest year for PE activity since before the financial crisis, as strong earnings, overall positive macroeconomic sentiment and the need to deploy more than US$700b in dry powder won out over the headwinds of increasing competition and continued high valuations. However, 2019 is off to a slower start as concerns around Brexit, escalating trade tensions and the late stage of the current cycle all seem to be coming to the forefront. In Q1 2019, firms announced transactions valued at US$96b, down 24% from Q1 2018.

Amid this backdrop, PE firms are seeking ways to remain active and engage in opportunities where they can add value while avoiding the worst of today’s high-price environment. PE firms are leveraging add-ons, growth capital, and complex carve-outs as strategies to build compelling portfolios and mitigate continued high valuations, which have averaged 10.6 times EBITDA over the last two years, according to Leveraged Commentary and Data (LCD).

Add-ons grow as sponsors look to lower average purchase multiples

PE firms have announced US$175b in global add-on acquisitions since the beginning of 2018, accounting for nearly a quarter of PE’s total spend. With large-scale platform transactions remaining prohibitively expensive in many cases, firms are looking to add-ons as a way to reduce their purchase multiples. Recent PitchBook analysis found that funds that execute more add-on deals generate better cash multiples across most vintages.

 

PE firms looking to add-ons

US$175b

in add-on deals since the beginning of 2018.

Moreover, as PE firms increasingly position themselves with late-cycle strategies, add-ons represent an accelerated path to scale versus strategies based solely on organic growth. And while historically fragmented industries represent some of the clearest targets for add-ons, the theme is currently playing out across a wide range of industries, including technology, health care and consumer products.

PE continues its move into growth capital

Globally, PE firms currently have more than US$200b in dry powder available for deals, up from US$94b just four years ago.

While still fairly small relative to the US$700b in dry powder controlled by buyout funds, assets targeting growth capital are currently growing at more than twice the rate of buyouts.
Brian Acampora
EY Private Equity Technology Leader

In some regions, notably Europe, the number of growth capital vehicles currently raising capital is exceeding the number of buyout vehicles for the first time ever according to Preqin data.

For PE firms, the space is compelling for a number of reasons:

  • A broader investible universe – the large amount of smaller family-run and entrepreneur-owned businesses not interested in selling to PE are often amenable to majority stakes.
  • Less intermediation – many of these companies are looking for partners with value-adds beyond capital, allowing PE teams to differentiate themselves in order to secure deals.
  • Timing is right to capture value – early movement positions PE firms to capitalize on increased growth rates and access to companies at earlier stages of their maturity curve.

Carve-out opportunities increasing as strategics recover from M&A hangover

After successive years of record-setting M&A activity, strategics are increasingly looking to divest many of their noncore assets in order to focus on their core businesses.

A number of dynamics are increasing the number of carve-out opportunities in the market. Increasing activity by activist investors is leading many companies to trim their portfolios on a proactive basis. According to a report from Activist Insight, in 2018 more than 900 companies received governance-related proposals from activists, a figure that’s grown more than 40% over the last five years. Moreover, reductions in the US corporate tax rate have reduced the tax burdens of large asset sales.  

The first quarter saw a number of high-profile carve-outs go to PE firms, including the US$3.4b acquisition of Evonik Industries’ methacrylates chemicals business by Advent International, and the acquisition of Kroger Co.’s Turkey Hill Dairy business by Austin-based Peak Rock Capital. For PE firms with the ability to execute, such deals can be compelling opportunities – relative to other deals types, the complexity involved with large carve-out transactions is a natural barrier to entry, allowing those firms with the sophistication and experience (and the right levels of dry powder) the opportunity to operate with less competition.  

Take-privates continue to offer opportunity for PE, despite a shrinking pool of targets

While still nowhere near the heady days of 2007, take-privates continue to offer a steady source of deal flow for PE firms, exceeding more than US$100b in activity last year.  Technology and health care are the largest target sectors for these deals – together, they accounted for almost two-thirds of PE take-private deals last year. If Q1 activity is any indication, momentum is poised to continue unabated. The first quarter of this year saw sponsors announce 16 deals valued at a collective US$37b.

Indeed, despite mounting concerns around slowing economic growth and the potential for increased market volatility, PE’s willingness to engage in these spaces is likely to effectively put a floor on public market valuations for the foreseeable future.

Looking ahead

Demand for PE’s unique competencies will remain high. Over the last 12 months, firms have raised more than US$675b – while off the peak of 2017, secular trends, including new investors to the asset class, will provide strong tailwinds. The challenge for firms, as we forge deeper into the macroeconomic cycle, will be to continue to develop disciplined ways of deploying capital in ways that stay true to their core identity, and which allow ample headroom for continued growth.

Summary

Amid a continued high valuation environment, PE firms are utilizing a number of different strategies in order to deploy more than US$700b in dry powder. Add-on deals, growth capital investments, take-private deals, and complex corporate cave-outs are all coming to the forefront as PE firms seek to remain active.

About this article

By

Andres Saenz

EY Global Private Equity Leader

Trusted advisor to leading private equity professionals and their portfolio companies. Ardent student of consumer behavior. Marathoner. Family man.