US mid-market: a galaxy of stars

The US mid-market comprises close to 200,000 companies with $10 million to $1 billion in sales, generating more than $10 trillion in combined annual revenue or one third of the country’s private sector GDP, according to the National Center for the Middle Market.

However, as valuations have risen steadily to double-digit ratios the pace of deal making has slowed. The impact has been visible in the $100 million-$500 million range – an area considered core in the mid-market – where the number of deals declined to 197, worth $32 billion, in the second quarter of 2015 from 233 deals ($46 billion) in the same period last year, according to PitchBook.

“If you look at the US today, mid-market deal activity has come down from 2014, but it’s still pretty strong,” says Reeta Kapani Holmes, co-managing partner of New York’s Silverfern Group, which makes private equity investments on behalf of 60 family offices.

“Relatively stable economic growth, investor confidence, available debt and an abundance of equity capital seeking yield have contributed to increasing acquisition multiples.”

Purchase multiples in the $100 million-$500 million range increased to 10.6x EBITDA for the first nine months of 2015, compared with 8.2x for the same period last year, according to Dealogic.

Meanwhile, rising valuations have spurred financial sponsors to focus on realisations through M&A, trade or secondary buyouts with other financial sponsors. That’s what happened in the case of this year’s largest mid-market transaction when Sweden’s EQT acquired California’s WASH Multifamily Laundry Systems for $995 million from Chicago’s CHS Capital in May.

Sales to strategic buyers accounted for 63 percent of mid-market exits for the first half of 2015, according to PitchBook. This included this year’s second largest exit in the $500 million-$1 billion range when TTM Technologies acquired Missouri’s Viasystems Group from HM Capital Partners and Black Diamond Capital Management for $950 million in June.

FUNDRAISING

Antoine Drean, chairman of fund advisory group Triago and founder of online marketplace Palico, says the current environment is the “best market I’ve seen for mid-market fundraising since the financial crisis”.

“The sector has reinvented itself in recent years, diversifying well beyond generalist buyout strategies,” he adds.

Even some mega-funds seem keen to tap the sector’s promise. Carlyle has amassed $1.7 billion this year for its second mid-market Equal Opportunity Fund II, which makes equity investments of $25 million-$150 million.

Meanwhile, data from PitchBook show mid-market fund managers had raised $62 billion in the first half of 2015, less than half the $140 billion raised last year. Even so, preliminary data from Probitas Partners shared with Private Equity International for its upcoming Private Equity Institutional Investor Trends Survey for 2016 indicates investor interest in the segment remains strong, with 77 percent of respondents saying they expect to focus on mid-market funds in 2016.

However, perhaps what is most surprising is the strong interest by LPs in funds, according to Drean. “What is impressive is the level of interest investors are showing in lower mid-market funds,” he says.

The number of lower mid-market funds with $100 million-$500 million in capitalisation that have closed in the first nine months of 2015 now stands at 42, fast approaching last year’s total of 57, according to PitchBook.

“We see a lot of endowments and foundations that are wanting to allocate out of the big brand name mid-market funds and are looking for smaller managers to invest, where their commitment often represents a substantial portion of the fund’s capital,” says Jeff Eaton, head of global origination at Eaton Partners.

John Guinee, managing partner of Constitution Capital Partners, suggests that while the top quartile performance of smaller buyout funds has long piqued the interest of LPs, another factor may also be at play.

“As it concerns the larger funds you’ve got a fair amount of headline risk with the discussion around fees, but in the lower mid-market the fee-heavy model is less prevalent,” he says.

One theme that’s been prevalent throughout the year has been the quickened pace of fundraising. Veteran healthcare manager Illinois’ RoundTable Healthcare Partners closed its fourth private equity fund at its hard cap of $650 million in less than two months. Other noteworthy speedy closers include Silversmith Capital Partners, raising $460 million for its debut partnership in just over three months, and Dallas’s Pearl Energy, which closed on $500 million for its debut fund in September or roughly three months.