Today’s uncertain global economic climate is the biggest challenge confronting the global PE industry, according to the findings of Grant Thornton’s annual private equity (PE) report sponsored by GTI titled: A force for growth.
US respondents in the study meanwhile, cited tough fundraising conditions, increased competition for deals, a looming industry shakeout and stricter regulatory requirements as major developments occurring in the North American (US and Canada) deal market.
The study, which is based on interviews with 144 buyout firm executives worldwide, revealed that successful firms are likely to have addressed the need to grow their portfolio companies by relying on operational improvements rather than financial engineering as a means to build value. Forty six percent of respondents cited becoming involved in important management functions as a major driver of growth, while 35% reported financial planning and 30% human resources as key factors in generating growth.
"We’ve seen the private equity investment model evolve in order to meet the challenges posed by global economic uncertainty, new regulatory requirements and additional LP requirements," says Steve Brady, head of Transaction Advisory Services at Grant Thornton. "Despite capital markets volatility and other developments taking place that will reshape PE, our survey found that the sentiment among respondents was overall optimistic."
Respondents highlighted the consumer sector as the most active area of investment in 2011, followed by business services, industrials/manufacturing, healthcare, telecom/media/telecommunications," says Brady. "It is significant that the consumer sector is cited as the most active. This could change if a double dip recession does occur."
The study also found that PE is well entrenched as a source of funding in North America with a significant number of U.S. middle-market companies owned by financial buyers. In spite of their strong domestic focus, 40% of North American GPs expect that cross-border M&A within their PE portfolios is likely to take place, primarily involving Canadian and US companies. These buyout groups demonstrated less interest in investing in businesses in Asian, European and Latin American countries because of the complexity in structuring deals, cultural issues and their lack of offices in foreign countries.
When it came to deal flow in North America, 52% of respondents thought that the majority of transactions would be derived from family-owned businesses and privately-held companies. The following 30% thought that secondary buyouts would account for their primary source of new deals, while 15% said corporate divestitures would account for the bulk of deal flow.
The study indicated that a shift in the relationship between PE firms and their limited partner investors (LPs) has taken place, favouring the latter. Funds that demonstrate high returns can raise capital from LPs more quickly, reflecting a flight-to-quality by investors. Comments by North American respondents indicated that investors, who are also seeking greater transparency and realised returns from exits, were more focused on investment strategies and fund documentation requirements in 2011. Nonetheless, the survey found many GPs were sanguine about raising larger funds despite increased reporting demands and a difficult fundraising climate.
The analysis revealed that new investor demands, coupled with increased competition for transactions from other financial sponsors and strategic acquirers alike, could spell trouble for some PE firms. Cited as the most significant challenge facing the private investment industry by North American GPs, increased competition for healthy company transactions between PE groups and strategic acquirers has already led to an increase in purchase multiples. As a result, the likely outcome from more competition and other challenges will create a period of "Darwinism," or survival of the fittest among financial buyers in coming years.
Respondents in North America believe that intense competition and new regulatory requirements, though, will create new jobs. Half of North American respondents, for example, said they anticipate increasing their organisational head count over the next year, largely in the areas of portfolio company management, back office research and deal origination.
