Exit activity vindicates PE model

The dramatic increase in exit activity last year in both the North American and European markets illustrates private equity’s ability to weather economic storms, according to Ernst & Young.

Exit activity by private equity groups almost doubled in Europe last year, rising 90 percent from 30 in 2009 to 57 in 2010, according to a report by accountancy group Ernst & Young.

North America also witnessed increased exit activity, with the number rising by 56 percent last year to 118, up from 76 in 2009. 

Jeffrey Bunder, global private equity leader at Ernst & Young, said this vindicated the private equity model.  “Private equity has performed well coming out of the recession as evidenced by the return of exit activity, particularly IPOs. It has proved itself far better able to weather the storm than anyone had anticipated in 2008. Over the long term, PE-backed businesses should continue to outperform public markets,” Bunder said.

Private equity has performed well coming out of the recession as evidenced by the return of exit activity

Jeffrey Bunder, Ernst & Young

He did however sound a note of caution, questioning whether this encouraging level of activity could continue given fears of a double-dip recession and public market volatility.

Although the markets this year have been particularly turbulent, their relative stability in 2010 saw IPOs return to vogue as a method of exiting investments. A total of 11 portfolio companies were exited this way in Europe last year – the highest number since 2006 according to the report.

The public markets proved a particularly popular exit route for large portfolio companies, as was evident from the mean size of IPO exits last year.

Bunder wrote: “The average entry EV for exits by IPO in 2010, at over €2.5 billion in Europe, is almost double the previous high of 2007. This demonstrates that the public markets have been a key route to realising large portfolio companies, with 2010 a particularly strong year for this. This was also true in North America, where the average entry EV for PE-backed IPO exits in 2010 was $1.1 billion.”

The E&Y study also examined returns. For both European and North American exits, it found that positive earnings before interest, tax, depreciation and amortisation growth through operational improvement was the most important driver of returns, rather than multiple expansion or gearing.  Cost reduction also played an important part, especially in North America where the recession was deeper and longer-lasting, the report found.

Harry Nicholson, a private equity partner at E&Y, said: “Within operational improvement, organic revenue growth is proportionally the largest contributor. In Europe, it accounts for 46 percent of profit growth across the six year study period and 42 percent in North America.”

When private equity owners changed a portfolio company’s management team, the GP's average holding period increased by up to 1.6 years in Europe and two years in North America, the study found.

More importantly, it also reduced returns by between 10 and 40 percent, depending on deal and geography, E&Y said, proving that having the right team in place at the start of an investment is key to its success.

The use of operating partners at private equity firms has increased, the study found, suggesting firms have learnt that by working more closely with their portfolio companies, they can generate better returns and weather the economic storm.