The Private Equity Conundrum: More Cash, Fewer Deals

The amount of dry powder in the hands of private equity funds continues to grow, even as deal-making slows sharply.

Michael Nagle/Bloomberg

Michael Nagle/Bloomberg

The private equity industry has a record amount of cash on hand to invest, which one might presume makes investors worry about overpaying for mediocre deals. But that doesn’t seem to be happening, according to consultant EY’s latest research.

Fundraising in private equity remains strong, with so-called dry powder reaching $732 billion as of June 2019, EY said. That figure is up from about $400 billion in 2012. PE firms brought in $155 billion during the second quarter of the year, slightly less than the $168 billion raised during the same time period in 2018.

But private equity firms are being cautious in putting that money to work. According to the report, the value of deals in the second quarter was $159 billion, down 4 percent from the second quarter of 2018. Over the last six months, the value of deals fell 13 percent to $260 billion.

[II Deep Dive: How Dry Powder Could Blow Up Private Credit and Private Equity]

Volume also dropped off. EY reported that private equity firms announced 476 deals in the second quarter, a decline of 11 percent from the year before.

The consulting firm largely attributed slowing deals to uncertainty about the economy and valuations.

“We haven’t seen deal-making reach where it was in ’06, ’07. Firms are being mindful about underwriting and cautious about how they deploy capital,” said Peter Witte, associate director of private equity at EY, who heads up research. “And at the same time valuations have been high. “Deals are at 11 times EBITDA, compared to 10.5 two years prior. So there hasn’t been a whole lot of relief on the valuations front,” Witte said.

Valuations were 9.5 times EBITDA between 2006 and 2007, Witte said.

“Investors are mindful about valuations. They don’t want to overcommit at the top of cycle,” said Witte.

PE firms are also trying to be creative about how they invest, he said, including doing more growth capital deals and complex carveouts. “They’re trying to pull every lever they can to put money to work, but in disciplined way.”

Private equity funds themselves are also getting larger as pension funds and other institutions continue pouring money into a handful of firms with the best track records. Private equity is a repeat business. Among the largest funds recently raised were Carlyle Partners VII, Advent Global Private Equity IX, and Hellman and Friedman Capital Partners IX.

“Especially on the buyout side, we’re seeing the trend of consolidation with a lot of larger asset managers. By consolidating with the best managers, investors can streamline their oversight process, save on travel, and are more likely to get breaks on fees,” said Witte.

Although overall fundraising was strong, the number of funds closed in the second quarter was down 41 percent from a year ago.

“But there’s still room out there for new managers. Spinoffs, for example, that have a demonstrable track record of success are a compelling strategy,” Witte said.

Private equity funds are also slowing their exits — realizing their gains or losses — from investments.

According to the report, private equity funds exited 285 deals (valued at $98 billion) in the second quarter. That’s down 34 percent from the same period in 2018. The bulk of the decline was due to mergers and acquisitions, which fell 40 percent in the quarter.

At the same time, the value of proceeds from initial public offerings increased by 36 percent in the second quarter of 2019, compared to last year. The number of IPOs, however, declined by 29 percent to just 25 deals.

“We’ve seen a shift away from IPOs as an exit strategy. Part of that is due to the volatility we’ve seen in the IPO markets and the open-and-shut nature of the IPO window,” said Witte.

Fundraising for private debt funds slowed substantially. In the second quarter of the year, firms’ fund raising for credit fell 32 percent to $28 billion. But Witte explained that part of this was due to some large funds that were raised last year, skewing the numbers.

During the first half of the year, firms closed 67 funds with $52 billion in commitments, down 19 percent in commitments from the same period in 2018.

However, capital raising for middle market direct-lending funds increased 72 percent during the first half of 2019. Thirty-three funds closed on $29 billion in commitments. Overall capital raised in the second quarter was up 38 percent for direct lending funds.

“We have seen some softening on the fundraising side over last few months, but I think we’re still talking about a market that is still fairly strong,” Witte said. EY said private credit funds are on track to bring in $120 billion for the year.

That target is easy to understand. According to EY, asset managers are raising 214 private credit funds and looking for $107 billion in commitments from investors.