Bain & Co: APAC GPs ‘feel the pain of sky-high valuations’

Fierce competition and a limited supply of high-quality targets has seen a record-setting rise in the average EBITDA-to-enterprise value for private equity transactions in the region.

Deal multiples in the Asia-Pacific region hit new highs in 2016, a report by Bain & Company revealed.

The average multiple of EBITDA-to-enterprise value for private equity-backed transactions in the region climbed to 17 in 2016 from 16.6 in 2015, almost double the EV/EBITDA multiple for US transactions (10.1).

The Asia-Pacific Private Equity Report 2017, which surveyed about 120 general partners and direct investors in the region, also noted that China has the highest priced deals, with overall M&A multiples rising to almost 30 in 2016, compared to 26 in the previous year.

The report attributes the rise in deal multiples to fierce competition and a limited supply of high-quality targets.

More than 80 percent of the GPs surveyed by Bain & Company said they “feel the current level of competition has increased”. They are also most worried about pressure from other regional and local private equity funds, strategic corporate buyers looking for opportunities to expand their footprint in the region, as well as large corporations such as China’s BAT companies (Baidu, Alibaba and Tencent).

Direct investments and co-investments by large institutional investors such as the Canada Pension Plan Investment Board, GIC and Khazanah are also putting LPs in direct competition with GPs. Most GPs also expect the growth of shadow capital to remain a new normal.

Steep Asia-Pacific multiples together with tightening interest rates squeezed traditional profit sources, are causing private equity firms to rely far less on traditional levers and look to new sources of value, the report noted.

“Wringing greater value from private equity investments is much more of a priority than it has been in the past. It’s also not as straightforward as it once was,” said Kiki Yang, who leads Bain’s Private Equity Practice in Greater China. “Funds that will thrive are those that understand they must exercise an entirely different set of muscles to win the best deals and unlock new sources of value.”

Meanwhile, overall deal value dropped to $92 billion with 892 deals in 2016, compared with $124 billion in 2015. The report noted that a decrease in deal volume was caused by slower growth in China, volatility in equity markets, and geopolitical uncertainty.

Moreover, funds in the region began 2016 with $137 billion of unspent capital and ended the year with $136 billion or almost two years’ supply at the current pace of investments.

While the amount of dry powder created strong incentive to put money to work, the report notes that “GPs for the most part showed great restraint in the face of inflated asset valuations.”

GPs in the region, however, showed continued appetite for high growth tech companies. The internet and telecommunications, media and technology (TMT) sectors attracted $42 billion or nearly half of total investment value last year. Internet deals alone accounted for more than a third of the total.

The report notes that amid fierce competition and record-setting multiples, GPs in the region will need to raise their game to produce market-beating returns. “They will have to source more effectively, bring a new level of rigor to due diligence, and develop a value-creation model that can win management buy-in for meaningful performance improvement—even in minority situations.”