Friday Letter: Fortress Europe?

Although private equity in Europe has a reputation for financial engineering, investors are seeing more upside from their investments

New research out this week from Ernst & Young shows that returns from private equity-based companies outperformed comparable publicly listed companies in Europe by a multiple of over 3x. While it’s not always an apples to apples comparison looking at public and private companies, the results are notable for the private equity industry which often gets cast as financial engineers and nothing more.

In its report titled: “A study of 2013 European exits” data from Ernst & Young shows that Private equity-backed IPOs have rebounded to a level not witnessed since 2006. Secondary offerings are not doing too badly either – follow-on offerings by PE firms raised $58.9 billion on 178 deals. The rate of creditor exits is down too.

While the IPO market in the US has been frothy for some time, bolstered by a multi-year equities rally, the rebound in Europe has been slower. This new data highlights an encouraging trend both for European markets writ large, and European private equity in general.

In 2008, public opinion of private equity in Europe went starkly negative as the public thought the industry played a direct role in the downturn. However, even though that opinion remains, it appears investors are laughing all the way to the bank. Report data shows that 13.79 percent of all investments made in 2010 posted positive returns. Gross investment return for exits in the 2005-07 period average 3.3X invested equity, with a gross internal rate of return of 40 percent to boot.

Report data suggests that portfolio companies may be feeling it too. The most important source of private equity outperformance comes from faster profit growth than comparable public companies, which is more important than smart or lucky buying and selling. Faster profit growth in PE-backed businesses has been driven by initiatives to increase revenue, for example backing new products, brands and market-entry strategies, and also operational efficiency initiatives. Overall, companies sold between 2005 and 2013 grew their EBITDA by over 8 percent per annum.

If these numbers carry over into 2015, they could be strong enough to help European private equity fundraising get back on level footing. Coming out of the crisis period a number of funds saw challenges and in some cases, outright failures when it came to raising money. But now, as exits increase and return multiples improve, a real recovery could be in the offing.

The real question for European private equity firms is whether the recovery is deep enough to move beyond momentary trends and easy financing. Investors too will have to see how recent price increases in the market impact returns. Watch this space.