Study: ‘Striking’ evidence that GPs add value

An Ernst & Young study charting 100 recent exits finds that private equity-backed companies gain value at double the rate of public-company counterparts, statistics that will bolster claims that the private equity ownership model is superior to that of public ownership.

A new study described as a “dispassionate, third-party view” by its sponsor, consulting firm Ernst & Young, has found that companies owned by private equity firms grow in value at twice the rate of similar public companies.

The study, released today and called “How do private equity investors add value?”, examines 100 private equity-backed companies that were exited by their financial sponsors last year. Ernst & Young  has already conducted similar studies based on 2005 and 2006 exits. However, this most recent study is the first to draw on exits globally, although the bulk were US and European.

John Vester, a principal in Ernst & Young’s Transaction Advisory Services and the leader of the survey, told PEO: “The evidence is pretty striking that [private equity general partners] add a lot of value through operations. They really are improving these companies – that’s the bottom line.”

Ernst & Young selected its survey pool based on the 100 largest private equity deals at entrance value to be exited in 2007, which Vester said minimised survivorship bias in the study.

Data came from public sources as well as from proprietary Ernst & Young interviews with managers.
Among the findings were that the average enterprise value of private equity-owned companies in the pool of 100 grew at a compounded annual rate of 24 percent, double the 12 percent rate of similar public companies. These numbers are similar to a similar Ernst & Young report based on 2006 exits, which found that private equity-owned companies outperformed public-market comparables by 10 percent.

More specifically, private equity-backed EBITDA growth rates in the pool were 33 percent ahead of comparable public companies, according to the survey.

Vester said that the private equity ownership benefits seemed to be most pronounced in the telecommunications and technology sectors.

Vester said his firm attributes private equity-backed outperformance to GP skill at targeting and timing good investments, skill at rapidly putting the best management in place, and to private equity’s powerful incentive structures, which dictate that strategic plans need to be executed immediately after the investment is made.

Proponents of private equity have long argued that the asset class has a superior corporate governance model over the public markets by dint of the control GPs exercise over portfolio companies. Some sceptics of this argument have maintained that private equity outperformance, where it exists, is often the result of financial engineering, including the application of leverage, and not operating improvements at the investment level.