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Private equity-backed businesses outperform public companies, says Ernst & Young

The annual rate of growth in enterprise value achieved last year by the largest private equity-backed businesses significantly outperformed equivalent public companies in the same country,

The annual rate of growth in enterprise value achieved last year by the largest private equity-backed businesses significantly outperformed equivalent public companies in the same country, industry sector and timeframe, according to a report by Ernst & Young.

Average annual enterprise value growth rates were 33 per cent in the US and 23 per cent in Europe, compared with public company equivalents of 11 per cent and 15 per cent respectively.

How Do Private Equity Investors Create Value? is the second annual study by Ernst & Young on the business performance and strategies of private equity firms, and covers the largest deals exited during 2006.

The study argues that the private equity industry is consistently able to grow and strengthen the companies under its ownership. The average enterprise value of the businesses studied in the US grew from USD1.2bn when acquired to USD2.2bn at exit. In Europe, the average value grew from USD800m to USD1.5bn.

Employment levels were the same, or higher, at exit versus entry in 80 per cent of US deals. In Europe employment in private equity-owned businesses grew by an average of 5 per cent a year across the UK, France and Germany, where two-thirds of deals took place, compared with 3 per cent for equivalent public company benchmarks.

‘Private equity ownership creates value from sustainable improvements in performance and growth,’ says Simon Perry, global private equity leader at Ernst & Young. ‘Two-thirds of the earnings growth in PE-owned companies comes from business expansion, with increases in organic revenue being the most significant element.

‘This includes the benefits of investment in sales and marketing, new product launches, acquisitions, investment into attractive industry sectors in the US, and expansion into new territories in Europe.

‘Cost reduction, including operational efficiencies, is also a very important element of earnings growth in both the US and Europe, accounting for 23 per cent and 31 per cent respectively of the total growth in earnings.’

The study suggests that private equity investors are highly selective and well researched when making the decision to buy a business, and have the ability to drive real efficiencies through the business plan under their ownership. This finding was true across deals in the US and all main European countries.

‘Three-quarters of investments resulted from pro-active research, including company or sector tracking, building relationships with management, or introductions from established contacts,’ Perry says.

‘Across almost all deals and ownership strategies, private equity investors were actively involved in the business after acquisition, making rapid decisions alongside management, challenging progress and making available specialist expertise. The intensity of engagement between private equity investors and management was often stronger than under the previous owners.’

Recent developments in the credit markets may have cast a long shadow, but Perry remains upbeat about the prospects for the private equity industry. ‘Private equity is facing a tougher environment with the recent squeeze on credit undoubtedly putting pressure on the financing of deals,’ he says.

‘This environment may prompt a more conservative approach with an increasing need for due diligence at acquisition. In Europe, a key challenge will be developing alternative exit routes alongside secondary sales. However, market participants view this as a short term dip in activity prior to returning to a more rational climate in 2008. There is widespread solid belief in the PE model and the long-term fundamentals remain strong.’

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