The private equity market reached new highs in the past 12 months with valuation multiples not seen since 2010 and record high dry powder in the US.
However, investors managed to remain disciplined in their investments. Deal volume was also hit by uncertainty and bouts of volatility in the equity and credit markets, particularly at the beginning of 2016.
Industry professionals weighed in on the trends and highlights in private equity in North America.
Dry powder increased
As of 30 November, dry powder in the US stood at $322 billion, representing 60 percent of the $536 billion global total, which is also a record, according to Ernst & Young, but investors were little worried about their ability to put the money to work.
“I don’t think where we are with dry powder is unreasonable if people are disciplined when using it,” Bill Stoffel, private equity leader at Ernst & Young, told Private Equity International. “We currently aren't seeing $20 billion buyouts but we are expecting an uptick in the number of billion-dollar-plus deals, which is the sweet spot for private equity and a great use of dry powder.”
“You shouldn’t look at dry powder as simply a number,” concurred Greg Stento, managing director at Boston-based HarbourVest. “It’s about how investors are using that dry powder, such as the pacing of capital deployment.”
Deal activity slowed down
The lower volume of deals indeed demonstrates this discipline in investing. It also reflects periods of volatility and uncertainty throughout the year. According to PitchBook, there were 2,477 completed private equity deals as of the end of the third quarter, putting deal volume on track to fall 18 percent year-on-year from 2015.
“Overall if you look at the M&A market as a whole, it wasn’t one of our strongest years,” CohnReznick’s private equity and venture capital principal Jeremy Swan said. “It was weaker than last year and most years, partly due to the lack of quality dealflow in the market.”
This slowdown was true across the spectrum, including in the mid-market, but it wasn’t a complete surprise, according to some.
“It was largely anticipated that the market would slow down,” Whitney Krutulis, director of business development who sources deals at Chicago-based Sterling Partners, told PEI. “There were less deals and less capital invested, but there’s still a lot of money people are looking to put to work.”
Valuations at highest levels since 2010
Low interest rates and availability of cheap debt fuelled high purchase price multiples. PitchBook indicated that as of 30 September, EBITDA multiples reached 11.2x, the highest since 2010 and up from 10.2x in 2015.
US mid-market valuations reached about 11x EBITDA on average this year, according to co-chief executive of mid-market firm Riverside Company Bela Szigethy, who was speaking at a media luncheon in December.
Some market participants said such high price tags were still worth investing in private equity considering that the asset class continues to outperform other strategies, such as public equity, over the long term.
“If you look at prices in a historical context, they may look full, but in a relative context we see investors having the ability to generate double-digit net returns in our asset class, which is pretty appealing,” said Chicago-based Adams Street Partners’ managing partner and head of investments Jeff Diehl.
The US, in particular, is attractive because the gross domestic product shows positive growth and a stable environment for investing, according to Stoffel. “When you think about private equity globally and where to put your money to make solid, risk-adjusted returns, the US is still the preferred destination.”
Increased focus on value creation
With such elevated valuations, the emphasis on value creation went up a few notches.
“Because valuations are so high, firms overall are bidding less on opportunities and choosing to spend time and resources where they’re comfortable paying the market multiple, where they know they have an element of differentiation,” Krutulis said.
Some of the value creation came from add-on acquisitions, which fetched lower EBIDTA multiples, a renewed focus on the value of operating partners, or both.