Private equity leaders anticipate another year of moderate deal flow volume, according to the fifth annual PErspective Private Equity Study by BDO USA.
Coming off of a year when rising valuations limited fund managers’ ability to source and close deals, only 15 per cent of private equity fund managers – regardless of fund size – predict they will close more than five deals in 2014. That represents a drop from 2013, when 22 per cent of fund managers anticipated closing more than five deals.
Despite this bearish view, fund managers are hopeful that they will deploy more capital in the year ahead.
According to BDO's study, 36 per cent of fund managers expect to invest more than USD100m in new deals or add-on acquisitions in 2014, a marked increase from last year, when only 23 per cent reported that they invested this same amount. Even so, fund managers are not expecting a return of the mega-deals seen before the 2008 downturn.
"Private equity transactions got off to a slow start in 2013, with highly sought-after new deals in short supply and the total volume of dry powder creeping back up," says Lee Duran, partner and private equity practice leader at BDO. "Looking to the year ahead, private equity fund managers are eager to put their capital to work and drive private equity purchases."
When it comes to exit activity, fund managers are continuing to see longer holding periods, similar to the study’s findings last year. The majority of fund managers (70 percent) responding to BDO’s study cite a longer expected average holding period now than compared to 12 months ago. Of those fund managers, 53 per cent report holding periods of 7-12 months longer, and 30 per cent expect holding periods of 13-24 months longer than the year prior.
In addition to longer holding periods, fund managers are anticipating a shift in potential buyers. More than half of private equity fund managers (54 percent) indicate that their exit assumptions have changed, with 25 per cent reporting an increased focus on sales to strategic buyers (down from 35 per cent last year), and 15 per cent anticipating an increased focus on sales to financial buyers (up from 11 per cent). Initial public offerings (IPOs) continue to be a less favourable exit plan as only eight per cent of fund managers say they are increasing their focus on the IPO market, up from just four per cent entering into 2013.
In alignment with the changes to exit assumptions, fund managers anticipate the greatest returns will be generated from sales to strategic buyers. In the coming year, 72 per cent of fund managers say sales to strategic buyers will generate the greatest returns, up from 64 per cent the year prior. Another nine per cent indicate sales to financial buyers will be the most lucrative, down from 11 percent, and seven per cent predict that the IPO market will generate the greatest returns on their investments, down from 15 percent. Only 11 per cent of fund managers say they are focused on long-term holds, as exits will not generate a return in the current market, up from nine per cent in 2013.
"Given the strong public equity markets and the significant amount of cash that is sitting on US corporations' balance sheets, strategic buyers, which have been very busy acquirers over the past few years, are likely to remain active," says Ryan Guthrie, partner in the private equity practice at BDO.
A plurality of respondents (32 per cent) – regardless of fund size – indicate that, other than North America, Asia – including Southeast Asia – will present the greatest opportunities for new investments in 2014. That’s up from only 22 per cent of fund managers who identified Asia as the market with the greatest opportunities looking into 2013.
"Up until recently, Asia hasn't been a core focus of capital due to complex market dynamics, but that seems likely to change," says Duran. “While Asia is certainly a diverse market and its private equity footprint is relatively small compared to other regions, we’re seeing that U.S. private equity firms are increasingly looking to Asia for opportunities."
South and Central America, which was considered the hottest area for investment looking into 2013 (as identified by 42 per cent of fund managers last year), dropped to second place this year, with 29 per cent of respondents identifying this region as having the greatest opportunities for new investments in the year ahead.
Diverging slightly from the pack, large funds – those with more than USD1bn in assets under management – indicate that Continental Europe (32 per cent) and South and Central America (32 per cent) will provide the greatest opportunities for new investments in the coming year, followed by Asia (18 per cent).
With regard to investments by industry, when asked which sector is likely to see the greatest opportunity for new investment in the coming year, 32 per cent of respondents identify manufacturing, up from 25 per cent last year. Technology and healthcare & biotech have also been deemed attractive sectors for new investment in 2014, with 17 per cent of respondents equally indicating that each of these sectors will provide the greatest opportunity, followed by natural resources & energy (15 per cent), retail (eight per cent) and media/information (six per cent). Another five per cent of respondents believe financial services will provide the greatest opportunities for new investments in 2014.
Despite these sectors’ attractiveness for investment in the coming year, fund managers cite both technology and healthcare & biotech (25 per cent each) as the industries that are most likely to experience increasing valuations in 2014. For technology, this marks an uptick from last year, when 21 per cent of fund managers identified it as the sector most likely to experience rising price expectations. For healthcare & biotech, however, this represents a slight decline from last year, when 30 per cent of fund managers identified it as the sector most likely to experience increasing valuations.
