Private equity firms have gotten used to record-breaking fundraises fueling pricey acquisitions. Is that set to end soon?
A new report from valuation advisory firm Murray Devine shows that deal volume and deal valuation have begun to diverge, which is typically a signal that a private-equity market cycle is coming to an end. In the first half of 2017, according to the report, $327.9 billion has been raised across a total of 1,808 investments, according to the report, which analyzed information from data provider PitchBook.
But the aggregate number of deals for the first half fell 15 percent year-over-year. What’s more, deal multiples are at a ten-year high, with private-equity buyers paying 13.7 times Ebitda — or earnings before interest, taxes, depreciation, and amortization — on assets. In other words, private-equity firms are paying a ton of cash for fewer assets. While prices are “only one component in the return calculus,” the report notes, Murray Devine found that the private-equity investments that have the best returns on investments were made in vintage years 2009 and 2001 — when prices for assets were much lower following the global financial crisis and dotcom crash, respectively.
Today’s soaring valuations signal that the multiples firms are paying for assets could soon decline, the report showed.
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“I don’t know that firms can pay a whole lot more than they’re paying at this point,” said Dan DiDomenico, senior managing director at Murray Devine.
To cope, many firms are looking at assets downstream for bolt-on deals — when private equity firms buy companies to add onto their platform companies — rather than major acquisitions. Private-equity firms are paying roughly 12.1 times Ebitda for small-cap ($100 million to $500 billion) deals. This is a major increase over 2016, when deal valuations in the small-cap market were between roughly 8 and 9 times Ebitda.
“More people are moving down the value ladder for bolt-on acquisitions,” DiDomenico said. “Those deals are more attractive.”
Though middle-market deals have also seen a boost in valuations, the increase is nowhere near as glaring as it is in the small-cap deal market.
“Valuations are likely being goosed by some of the larger global buyout shops that have beaten a path into the segment in search of deal flow,” according to the report.
Regardless of deal size, private-equity firms continue to beat out their strategic peers when it comes to buying assets. In the consumer sector, for instance, private-equity firms are on track to outpace strategic buyers for the first time in three years, according to the report. DiDomenico notes that most strategic buyers are still waiting on a potential tax holiday to put overseas cash to work. These strategic buyers are paying on average 10.5 times Ebitda for assets, compared with the 13.7 times Ebitda private-equity firms are willing to pay.
“They can’t sit on the sidelines waiting for the tax holiday,” DiDomenico said of these strategics. “I have a few strategic clients. They’ve lost out to private-equity buyers because those guys are willing to pay higher multiples.”
He added that he expects to see some clarity in the second half of the year as to whether these companies will get back into the M&A game, creating more competition for private-equity buyers.
For the time being, though, private-equity buyers remain king.
