Private equity deal valuations are ticking up and firms are increasingly turning to debt as a means of funding deals, according to new data from Pitchbook.
Still, most private equity investors are bullish on being able to ensure typical returns for the asset class, according to the Pitchbook report, which was published on Monday by the private capital market data provider.
“There are fewer and fewer low-priced deals being completed in an environment where competition remains fierce across all target company sizes,” the report said.
Intense competition and high deal prices have not swayed investors, though. Pitchbook’s data show that more investors are confident that deal pricing will allow for typical private equity returns than they were in 2017.
This year, 58 percent of investors said they believed returns would allow for typical returns, as compared with 52 percent in 2017. This comes as the median enterprise value to earnings before interest, tax, depreciation, and amortization (EBITDA) ratio has grown since last year. In 2017, that ratio was 7.9x in 2017, as compared to 8.3x in 2018, Pitchbook data show.
In other words, deal prices since last year have increased, but so has investors’ belief that the assets will perform well over time.
One way that private equity investors are ensuring that their bullish outlook comes true is by acquiring companies with strong revenue growth, according to Pitchbook. Firms are looking to software and other fast-growing companies, and as a result, have the highest expectations for targeted company revenue growth since 2013, the data show.
“This could also reflect a desire for PE firms to buy growing companies, as they know financial engineering for low-growth companies is not enough to drive top-quartile results,” the report said.
That is not to say, though, that private equity firms are not using at least a little bit of financial engineering when it comes to deals.
Private equity firms are stacking some deals, particularly the smallest ones, with more debt, the report said. This is despite the fact that smaller deals are thought to have more risk inherently, according to Pitchbook. Deals worth $25 million or less are made up of 56.1 percent debt on average, the report showed.
Translation: some firms are adding risk to an already risky asset, which may not pay off in the long term.
A spokesperson for Pitchbook declined to comment further on the report.