Coming off of a strong year for private equity in 2014, industry leaders are tempering their outlook for 2015, according to the sixth annual PErspective Private Equity Study by BDO USA.
While 41 per cent of private equity fund managers report closing more than five deals in 2014, only 8 per cent expect to do so during the next 12 months. Instead, the vast majority (87 per cent) of private equity sponsors expect to close between one and five deals in 2015, with the largest percentage (30 per cent) of fund managers predicting they will close only two new deals in the year ahead.
These modest projections are mirrored in fund managers' view of the current investment environment: 56 per cent characterise the markets as either very or somewhat favourable, a decline from the 72 per cent expressing a positive outlook in 2014. Another 36 per cent go as far as to say today's environment is somewhat unfavourable compared to only 24 per cent who said so one year ago.
"Private equity experienced a big year in 2014, as the availability of cheap debt, overhang of dry powder and relative optimism about the US economy contributed to a high volume of deal flow. Funds needed to deploy cash," says Lee Duran, Partner and Private Equity practice leader at BDO. "While signs are still positive for 2015, fund managers are cautious, eyeing currently high price multiples, potential interest rate hikes and ongoing competition from strategic buyers as factors that could impact deal flow in the year ahead."
Despite a modest overall outlook for 2015, fund managers say they expect their new deals and add-on acquisitions to be larger during the next 12 months than they were in 2014. One in four (25 per cent) expect to invest between USD101 million and USD1 billion in 2015, compared to 17 per cent who did so in 2014. Another 42 per cent (vs. 36 per cent in 2014) expect to invest between USD30 million and USD100 million. Only 4 per cent of fund managers expect to invest more than USD1 billion in 2015, indicating that 2015 could be the second consecutive year of few, if any, mega-deals.
According to private equity fund managers responding to BDO's survey, private company sales and capital raises (43 per cent) and private equity funds exiting their investments (41 per cent) will be the key drivers of private equity deal flow in 2015.
Following a strong year for sellers, only 58 per cent of private equity fund managers say their current expected average holding period for investments is longer than it was 12 months ago. That's the lowest percentage to report longer exit timelines since BDO began conducting its PErspective Private Equity Study in 2009. Of those who do expect longer holding periods, the largest percentage (39 per cent) expect exit timelines to increase by 13 to 18 months.
Of the 42 per cent of fund managers who report shorter average expected exit timelines, 29 per cent expect holding periods to decrease by 7 to 12 months and 42 per cent expect them to decline by 13 to 18 months.
While exit timelines have shifted, exit assumptions have remained fairly consistent, with 41 per cent of fund managers reporting no change in their preferred exit routes when compared to 12 months ago. The largest percentage of survey respondents reporting a change (25 per cent) say they have increased their focus on sales to strategic buyers and another 18 per cent say they have increased their focus on sales to financial buyers.
These findings reflect expectations for returns: 73 per cent of private equity fund managers expect sales to strategic buyers to generate the greatest returns during the next 12 months, followed by 14 per cent who expect sales to financial buyers to be the most lucrative exit option. Fund managers report a conservative outlook on IPOs, with only 9 per cent saying public markets will generate the greatest returns in the coming year.
"The US IPO market experienced significant growth in 2014 and many private equity firms were able to capitalise on the momentum through public offerings," says Ryan Guthrie, Partner in the Private Equity and Transaction Advisory Services practices at BDO. "We expect fund managers to continue to evaluate public markets as a viable exit option, while recognising that it will be hard for 2015 proceeds to match 2014 levels."
The top challenges fund managers anticipate when exiting current investments include the gap between buyer and seller pricing expectations (73 per cent), followed by financial information uncovered by buyers' third-party diligence providers (17 per cent).
For the third year running, the largest percentage of fund managers (34 per cent) cite Manufacturing as the industry providing the greatest opportunity for new investment during the next 12 months. Fund managers' projections for investments in the Healthcare & Biotech and Technology industries remained nearly flat when compared to 2014, with 15 per cent and 18 per cent, respectively, identifying these industries as the leading investment targets for the year ahead.
"US manufacturing was in high demand in 2014, driven by a number of factors including innovation, regionalisation, reduced energy costs and the overall US economy," says Dan Shea, Managing Director with BDO Capital Advisors, LLC and a member of BDO’s Private Equity practice. "While this spurred an uptick in sector valuations, we expect to see purchase price multiples level off in the near term and interest in the sector to remain strong."
When it comes to valuations, fund managers believe that Technology (70 per cent), Healthcare & Biotech (67 per cent) and Manufacturing (37 per cent) are the most likely to be among the top three industries to experience increases during the next 12 months. Conversely, Retail & Distribution (57 per cent), Natural Resources & Energy (53 per cent) and Financial Services (52 per cent) are among the industries most likely to experience decreasing valuations in 2015.
“Given recent fluctuations with commodity prices, it’s no surprise that fund managers are keeping a close watch on the oil and gas sector,” says Brad Ross, director with BDO’s Transaction Advisory Services. “With prices continuing to drop in the new year, private equity firms already invested in the industry may be concerned about their ability to turn a profit on new investments in the short term.”
These findings are from the sixth annual BDO PErspective Private Equity Study, which was conducted from November through December 2014 and examined the opinions of more than 125 senior executives at private equity firms throughout the US.
Other major findings from the BDO PErspective Private Equity Study include:
• Sights Set on Asia, South America and Central America: More than one in four private equity fund managers (28 per cent) expect to pursue cross-border transactions during the next 12 months. When evaluating opportunities outside of North America, Asia was the top-ranked geography for new investment opportunities for the second year in a row (41 per cent vs. 32 per cent in 2014), followed by Latin America (30 per cent vs. 29 per cent in 2014). Fund managers' outlook on Eastern Europe, however, changed dramatically, with only 1 per cent of private equity fund managers saying it is the top market for investment opportunities in 2015, compared with 13 per cent when looking into 2014. This may be due to regional unrest driven by ongoing conflict between Russia and Ukraine, as well as Western sanctions impacting the Russian economy.
• The availability of local resources (27 per cent), regulations impacting cross-border acquisitions (26 per cent) and cultural nuances (19 per cent) are the primary challenges fund managers expect to face in evaluating or executing cross-border transactions.
• Focus on Buy & Build Strategy: Ninety-one per cent of fund managers indicate they sought add-on acquisitions in 2014 and 95 per cent say they will do so in 2015. At the same time, while the majority of private equity fund managers (67 per cent) continue to report deploying the most capital through new deals during the past 12 months, more than one in five (22 per cent) say bolt-on acquisitions received the majority of their funds in 2014. This reflects private equity firms' continued focus on growing their existing portfolio companies.
