GPs seek buy-and-build amid high valuations

GPs are holding on to assets longer as they seek to balance out lower IRRs with higher cash multiple returns, said UBS’ Nestor Paz Galindo.

Private equity dry powder rose to $1.4 trillion in the second quarter as managers struggled to put capital to work amid high valuations, said Nestor Paz Galindo, head of sell side and financial sponsors M&A at UBS.

“This is a difficult market to invest in, valuations continue to be an issue for some of these investors,” he said.

A number of multi-billion dollar funds are currently fundraising or have closed in the last 12 months, such the $13 billion Advent International Global Private Equity VIII, and the €7 billion Sixth Cinven Fund. Many of these vehicles will have to look outside their equity ticket ‘sweet spot’ to deploy capital.

“In the current environment, sponsors certainly need to be more creative to find new deals and ways to create value,” Paz Galindo said, noting a trend for buy-and-build transactions.

“As part of searching for new opportunities to invest, sponsors are more and more looking at platforms for a buy and build strategy, where they can deploy subsequently more capital and generate returns through synergies and scale.”

In the third quarter of 2015, platform companies carried out 125 add-on transactions in Europe, the highest number since Q2 2008, and 404 add-ons over the year, up on 2014, according to Silverfleet Capital’s report European Buy & Build in 2015.

And the data is there to back up the thesis. A study from Boston Consulting Group shows that investments in which a portfolio company acts as a platform for further add-on acquisitions outperform standalone deals, generating an average IRR of 31.6 percent from entry to exit compared to 23.1 percent for standalone deals.

The average hold period for a private equity portfolio company has increased from around 4 years in 2009 to 6 years today as GPs work their businesses harder to drive money-on-money returns, Paz Galindo noted.

Although longer hold periods have a negative effect on IRRs, the aim is to generate roughly the same returns for investors in absolute terms.

One result of this trend is that pure-play private equity funds are starting to compete with infrastructure funds, particularly on very stable, low yield assets in the cross-over point between the two asset classes.