The Verit View – October 2012
While recent deal volume has slowed, Verit Advisors’ view is that private equity activity will accelerate through the end of 2012 and very likely into 2013. A number of macroeconomic factors contribute to this perspective, including high levels of unspent capital commitments, uncertainty over future tax rates, the emergence of fund-to-fund transactions, ready availability of credit at historically low rates, a backlog of portfolio companies that have been held for at least three years, an increasing focus on operational – as opposed to financial – engineering, and overall economic expansion following several years of negative to anemic growth in the U.S. economy. We discuss three of these in detail below.
Cash, Cash, Cash
As a class, private equity boasts a record amount of capital to invest. According to a report released in August by Preqin Ltd., assets under private equity management rose 9% last year; by the end of 2011, $3 trillion in assets under management were held across the entire industry, the first time that threshold has been crossed. This is not surprising, given the unprecedented amount of capital commitments that were made to the asset class in the middle of the last decade, when hundreds of billions of dollars each year were earmarked for private equity. The flip side of the equation, private equity investments, have been comparatively quiet during the Great Recession. For example, in 2006 and 2007, private equity in the U.S. invested $1.31 trillion in nearly 5,600 deals; in the four-and-a-half years since then, total investment equaled $1.28 trillion. This significant slowdown, as tracked by PitchBook Data, Inc., means private equity general partners currently have significant capital resources at their disposal. If past is prologue, accelerating deal activity should follow.
Portfolio Company Backlog
At the end of June 2012 there were over 6,200 private equity portfolio companies in the U.S., and of those, more than 4,000 had been held by funds for three years or more. To put this in perspective, at the end of 2006 there were fewer than 3,800 portfolio companies in total according to PitchBook. With typical targeted holding periods of three to five years, most private equity funds begin to seriously consider exiting their investment at the 3- to 4-year mark. Coupled with improving credit market conditions, low interest rates, and rebounding public equity markets, this abundance of mature portfolio companies is a harbinger of divestitures to come.
As recently reported in The Wall Street Journal, nearly $30 billion in U.S. deals between private equity funds have been announced this year, more than double the amount for all of last year and on pace to be the most since the high-water mark of $51 billion in 2007. This acceleration of what are commonly referred to as secondary buyouts has been fueled by the factors discussed above, but also by the limited availability of alternative exit strategies. The current market for initial public offerings is relatively poor but for a select number of industry sectors. Corporate buyers have shown little interest in making aggressive purchases of late. Private equity funds, on the other hand, need to transact in order to generate returns for their investors and to manage the life cycle of their funds. The math is simple: because timing is an important investment consideration for private equity funds, when IPOs and strategic transactions are unavailable these funds are increasingly turning to each other for deal volume. Moreover, as the private equity industry has matured and grown, there are more funds with more liquidity specializing in narrower industry niches and/or targeted growth strategies. Secondary deals today are strategic, leveraging operational engineering more so than yesterday’s investments that focused on financial engineering.
As always it is Verit’s vision to bring a fresh approach and customized solutions to advise private business owners on ownership transition.