Mid-market private equity enjoyed a renaissance last year. Hopes were high that this momentum would be maintained in 2011, but evidence from the first nine months of the year suggests otherwise – deal volume to Q3 2011 totalled 109 compared to 132 in the same period last year, with the value of deals falling from £4.4 billion to £3.9 billion over the same timeframe. So what is behind the disappointing performance and what can we expect in the rest of the year and in 2012?
One of the key factors behind the fall in mid-market transactions has been the resurgence of trade buyers. There is no question that corporates are now much more competitive as the cost-cutting measures taken as a response to the financial crisis have begun to have a positive impact on their bottom lines. Corporates now have the firepower to buy growth again and have been running the rule over potential acquisitions.
Another factor is business owners’ expectations. Certainly some owners are more realistic in their pricing. The temptation for owners of an asset to time the sale of that asset with a period of over-trading or over-exuberance in the capital markets is clearly not as likely as it was pre-2007 but some owners remain too optimistic in their hopes.
One trend that we saw earlier this year which I think will continue to strengthen, is that of larger private equity houses competing more in the mid-market. Blackstone’s recent purchase of Tangerine Confectionary, for around £100 million, is one of the best illustrations of this trend.
What they are trying to do is to replicate the kind of returns in the mid-market that they achieved, often with financial engineering playing a bigger role, on larger buyouts. So in that sense, the global private equity houses will have to adapt their models to compete and rely more, as mid-market houses do, on generating better performance through mainly operational, rather than capital or financial, improvements to a business.
Looking forward at the prospects for the mid-market over the rest of this year and into 2012 it is hard to be optimistic for the market, which is closely calibrated to overall economic growth. Undoubtedly business conditions are tough and mid-market deals have fallen this year, but they have not ground to a halt and they are still being done.
Investment teams just have to work harder to spot the right opportunities as even in downturns, pockets and sub-sectors of the economy, particularly in innovative areas such as TMT and business outsourcing can still perform. Also given that specific company valuations are often depressed due to general business conditions, private equity teams that do recognise the right team to back can generate much better returns on exit than if those businesses were acquired during boom years.
If policymakers can come up with a coherent solution to the current sovereign debt crisis then given GPs are still sitting on large cash war chests, they could take advantage, but the situation is currently very fluid. I still believe we will continue to see most exits go to trade. Sales to financial buyers will take the form of secondary buyouts as they can be completed more quickly than an IPO – where conditions in public markets are not favourable anyway.
For LDC, though the overall market is closely tied to economic growth, we believe that we have the skills and investment expertise to keep identifying great management teams, which can deliver above average growth rates. And in accordance with our philosophy of investing through the cycle we are continuing to do transactions. Despite its critics and the economic downturn the private equity industry is still with us and may confound everyone with an upside surprise.