The fine folks at Pitchbook recently published their Q3 2015 Private Equity Breakdown and there are 3 key story lines to note:
• U.S. – based PE exits in throughout 2014 and H1 2015 were and remain at extraordinary levels in $. In 2014 PE exits totaled $167 Billion, a record, but with the rate of exits in 2015 that value will be exceeded by the time you read this. And we’ll have 5 months left in the year!
• The Investments-to-Exits ratio (based on # transactions) was only 1.7X for H1 2015, the lowest ratio in 10 years. To some degree, the PE industry is “emptying the closet”.
• Corporations are the big customers for such exits, outspending larger PEs 8:1 in H1 2015, and they likely will double their spending over 2014 by year-end….exceeding $300 Billion.
What is going on and why?
- Enterprise Value/EBITDA multiples have been at 10 year-highs for 2013-2014; 10X per Pitchbook’s recent report, and a recent Deloitte analysis of the Middle Market (less than $50 million EBITDA) supports that lofty multiple. I have often called the PE industry the “Canary in the Mine Shaft”; the actions of the industry portend macro-market changes. In this case, valuations are so high they cannot not sell.
- Private Equity firms I speak with have lamented the dearth of good quality platform deal opportunities for the past 18 months or so. My view: more than a few business owners enjoy riding the wave of this business cycle, they think they can obtain a better price (“we want 10x”) in the future, and find current reinvestment options unappealing.
- Public Mid-Cap corporations have lowered their after-tax Cost-of-Capital by nearly 200 basis points since 2011, per Deloitte. They thank the Federal Reserve and a buoyant equity market, and lowering the critical hurdle rate on investment returns fuels their ability to pay higher multiples than past years.
- Public corporations have record amounts of cash/cash equivalents on their balance sheets. FACTSET published a Q1 2105 report showing the S&P 500 (exl. Financials) had record cash holdings of $1.43 Trillion at Y/E 2014. Those funds either earn low rates in U.S. Government securities, or go to work in CAPEX, internal development, or acquisitions.
Some Implications:
- The rising wave of EV/EBITDA multiples will crest at some point. The returns expectations for PE investors and PE firm partners don’t tolerate investment made at 10X purchase price multiples. I.e., “my exit metric is not my investment metric.”
- Platform-sized businesses of good quality are in short supply and when effectively marketed will likely close on a relatively short timetable.
- Corporations have opened the coffers for acquisitions and may offer superior deal values to selling business owners for some time to come, particularly for smaller acquisitions which PE terms “add-ons”.
Posted by Stephen Hauser.