GPs worry about returns amid record high prices

Entry valuations of 10x earnings during 2016 exceeded crisis levels, but leverage and capital invested is still down on previous highs, says Bain & Co.

Asset prices for private equity buyers have exceeded levels seen before the financial crisis, as investors “wielding record amounts of capital continue to bid up acquisition multiples,” says consulting firm Bain & Co.

In its Global Private Equity Report 2017 the consultancy said that acquisition multiples are now running at more than 10x for leveraged buyouts in the US and Europe as “plentiful low-cost debt in the hands of yield-hungry creditors adds upward pressure on prices and ensures they will stay high.”

Hugh MacArthur, Bain’s head of global private equity and author of the report, said that the consequence of rising prices is that “GPs find it increasingly difficult to pencil out how assets bought at prices today will achieve targeted returns.”

In a report which strikes a largely downbeat note, the firm said that while leverage ratios remain lower than during the run up to the crisis, at 5.3x and 4.8x Ebitda in the US and Europe respectively, compared with 6.1x in 2007 in both markets, the majority of loans were covenant-lite, as GPs hunt for yield in an environment of “superabundant capital.”

“Everyone is chasing yield, and where investors spot a sliver of extra yield, they pile in and bid down returns. Outsized returns that GPs could earn on once-common undervalued assets are harder to find today,” the report noted.

Despite record prices and diluted returns, the total value of private equity buyouts globally, at $257 billion in 2016, is still a long way from the $685 billion 2007 high, which was driven by a swathe of mega-deals. Bain said that while deals greater than $10 billion “are feasible without a consortium” given the size of the largest funds, banks remain reluctant to finance the type of mega-deals which stoked the pre-crisis numbers.