IPOs accelerate private equity exit activity in North America
Improving economic conditions in North America saw 2013 fuel the highest level of volume and values by entry enterprise value (EV) for private equity (PE) exits since 2006, according to EY’s annual North American PE exit study.
The report, Returning to safer ground: How do private equity investors create value? A study of North American exits, highlights that IPOs drove exit activity in 2013.
Increased public market demand and a return of corporate buyers meant that IPOs accounted for 61 per cent of aggregate PE entry value of exits.
The report, now in its eighth year, examines the results and methods of 893 exits between 2006 and 2013.
As the IPO market reached record levels in 2013, PE was well positioned to exit some of the largest companies acquired prior to the financial crisis. In 2013, the percentage of PE exits via IPO with an entry EV of USD1bn or more was 30 per cent, and 25 per cent of deals with an entry EV of USD1bn or more were acquired by M&A buyers, a significant increase from 14 per cent in 2011. With 169 exits at USD203bn by entry EV last year, North American PE is making significant progress in exiting its portfolio and has the best trajectory since the crisis.
Jeffrey Bunder, EY’s global private equity leader, says: “The improvement in overall market conditions is having a very positive effect on the prospects of portfolio companies particularly those most affected by the recession. The acceleration of PE exits is putting a dent in years of increased holding periods and the perception of stuck assets. PE is clearly taking advantage of a robust IPO market and an increased demand for M&A among strategic buyers to exit portfolio companies, continuing to provide liquidity to limited partners, to address the impact of longer hold periods.”
The study warns, however, that while public market conditions have allowed for more PE exits via IPO in 2013, this has come at a cost. The rise in market capitalization of PE-backed companies has led to a reduced proportion of shares being listed via IPOs. PE backed companies listed an average of 26 per cent of shares last year, compared to 40 per cent in 2006. PE firms have also reduced the amount of shares they sell via IPOs from 43 per cent of shares sold via IPO in 2008 to only 16 per cent in 2013. This translates into greater volatility and risk to returns, which are increasingly tied to post IPO share performance.
Thirty-one per cent of deals exited in 2013 were associated with buy-and-build strategies, compared to a 21 per cent average since 2009. As a result, cost-cutting measures, a prevalent strategy in the pre-crisis years is a less significant contributor to value. Cost reduction accounted for 30 per cent of EBITDA growth in 2006 and 2007 exits. In contrast, this percentage fell to just 16 per cent from 2010 to 2013 as PE concentrated more on other value creation strategies, particularly buy-and-build.
Michael Rogers, EY’s global deputy private equity leader, says: “In the post-recession era, PE has adapted its value creation strategy to suit the market environment. While strategies of investing in growth sectors and accelerating growth from the core business were the predominant means of creating value in prior years, 2013 exits exhibit a definite trend toward PE houses pursuing buy-and-build strategies.”
When examining revenue growth as a whole, organic revenue growth is by far the largest component of growth for PE-backed companies in North America. Over 46 per cent of EBITDA growth was driven by organic revenue growth, which has far outpaced comparable public companies. Overall, buy-and-build strategies, coupled with organic revenue growth initiatives have delivered PE EBITDA growth that has far outpaced comparable public companies. In the last three years PE-backed companies have expanded EBITDA by 12.9 per cent, almost double the 5.6 per cent rate of comparable public companies.
Many of the portfolio companies acquired before the recession were sold last year, a trend that is continuing this year. If the IPO window remains open, and if corporates continue their return to the M&A markets, PE should be well positioned to maintain the pace or even accelerate it. And while average holding periods in 2013 increased to 5.4 years compared to 4.4 years in 2012, there is growing pressure for holding period lengths to return to previous levels. PE will need to continue to find ways of increasing its exit pace if it is to reverse this trend and boost its initial rate of return profile.
Bunder says: “Post-crisis, PE strived to restore value lost in a number of companies during the downturn. Many of these have now recovered to the point where they can be profitably exited. A large majority of the industry have cited favourable market conditions as reason to exit in 2013. This feeling underscores the benefit of PE’s long-term investment cycle. With the effects of the recession slowly receding in the rearview, PE’s ability to ride-out the storm and pivot business strategies with an emphasis on repositioning operations and driving growth have crystalised into successful exits.”
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