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Pricing and availability of quality targets are top challenges for PE funds in 2014, says BDO

Private equity fund managers believe pricing will be their most significant challenge in 2014, according to the fifth annual PErspective private equity study by BDO USA.

When asked to rank the challenges private equity firms will face in the coming year, 39 per cent of fund managers cite pricing as their most significant hurdle, a marked uptick from just 15 per cent of respondents who says the same in last year’s study.
This coincides with rising purchase price multiples, which increased to approximately 9.8 times EBITDA in 2013, up from 8.3 times in 2012, according to Preqin.
The second largest percentage of fund managers (34 percent) say the identification of quality targets will be their number one challenge in 2014 (up from 28 per cent in last year's study), pointing to ongoing concerns about deal flow in the wake of a slow year for private equity deal sourcing.
"We’re seeing an increased number of financial and strategic buyers competing for deals, as well as increased access to debt, leaving many fund managers concerned about their ability to source and close quality deals in the year ahead," says Lee Duran, partner and private equity practice leader at BDO. "While compelling investment opportunities do exist, private equity firms will need to be extra diligent as they work to find quality companies that are priced right in today’s frothy market.”
Despite anticipated deal flow challenges, 2013 was a robust year for private equity returns, with three-in-four survey respondents seeing the value of their entire portfolio increase during the past 12 months, an 11 per cent uptick from the year prior. Only 12 per cent of fund managers report a decrease in the value of their overall portfolio (down slightly from 15 per cent last year) and 13 per cent of respondents indicate that the value of their portfolio stayed the same in 2013 (down from 21 per cent last year).
"This was a good year for private equity investors, who profited greatly from private equity funds taking advantage of a seller’s market," says Dan Shea, managing director with BDO Capital Advisors and a member of BDO’s private equity practice. "Strong exits led to private equity sponsors returning a record amount of cash last year."
Of the 75 per cent of fund managers who saw the value of their portfolio increase during the past year, the largest group (49 percent) reports increases of between six and 15 per cent, followed by increases of 16 to 25 per cent, reported by 31 per cent of fund managers. Another 11 per cent saw increases of between 26 and 35 per cent, and five per cent of respondents report increases of more than 35 per cent.
For fund managers who saw their portfolio decrease, the largest percentage (44 percent) indicate that the fund's value decreased between six and 15 percent. Another 33 per cent indicate their fund's value decreased less than six per cent, and 11 per cent of fund managers saw the value of their current portfolio decrease between 26 and 35 per cent and 46 and 50 per cent, each.
Despite a strong year for overall portfolio performance, some individual companies continue to struggle. In fact, one-in-five fund managers say more than 20 per cent of their sponsored companies are performing below forecasts or expectations, and another 20 per cent are seeing six to 10 per cent of their portfolio companies underperform. Only 14 per cent of fund managers say none of their portfolio companies are performing below forecasts or expectations.
Reinforcing findings from last year’s study, when 26 per cent of fund managers ranked maintaining portfolio company performance as their most significant challenge (down to 17 per cent in this year's survey), private equity firms say they are continuing to actively manage portfolio company operations to mitigate losses:
• Sixty-five per cent of fund managers report that they reduced headcount for portfolio companies that are performing below forecasts or expectations, up from 58 per cent last year.
• Similarly, 61 per cent of fund managers say they reduced costs by scaling back, 63 per cent of fund managers renegotiated debt for poorly performing portfolio companies and 70 per cent are monitoring portfolio company cash flow on a weekly basis.
• The majority of fund managers (80 per cent) indicate that they are reassessing market strategy for portfolio companies that performed below forecasts or expectations, up from 72 per cent last year.
• Private equity fund managers are also increasingly hiring turnaround professionals, with one-quarter of fund managers indicating they did so in the past year, up 39 per cent since last year.
While portfolio companies have faced losses in the past year, bankruptcy filings remain low, with only eight per cent of fund managers indicating that they declared bankruptcy for one or more portfolio companies in 2013. The outlook is even brighter for 2014, with only six per cent of fund managers anticipating they will have to file for bankruptcy for one or more portfolio companies.
When it comes to hiring at portfolio companies, nearly three-in-four fund managers (72 per cent) plan to increase professional staff headcount at the operating company level in the coming year, an increase from 63 per cent who say they increased professional staff headcount during 2013.
Hiring plans at the fund level are less aggressive. The majority (54 per cent) of fund managers did not increase fund employee count in 2013, and 56 per cent of fund managers plan to keep hiring at bay in the coming year.

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