Private equity (PE) exit numbers dropped in Europe last year to 61 from 2011’s total of 85, according to Myths and challenges – How do private equity investors create value?, Ernst & Young’s annual study of European PE exits.
The report cites a volatile economic climate and low transactions activity as the primary challenges for PE.
However, despite the criticism sometimes levelled at the industry, in aggregate terms PE-owned businesses grew employment by two per cent in 2012. Forty-four per cent of the businesses studied made add-on acquisitions, while only 10 per cent made disposals. Eighty per cent delivered gross returns to investors above leverage and market returns from 2005 to 2012.
Sachin Date, Ernst & Young‘s Europe, Middle East, India and Africa private equity leader says: “With Europe and many other regions showing little or no GDP growth over such a prolonged period, the PE portfolio has inevitably been affected. Profits growth in businesses exited in the boom times was running at over 15 per cent a year; the figure for businesses exited in the last two years has fallen to five per cent – demonstrating that driving growth in the portfolio has become very difficult indeed. Ultimately, the knock-on effects of this trend lead to some stress in the industry as investment returns decline, investors become selective, and some firms struggle to raise a new fund.”
Since the onset of the crisis, the PE industry has seen low levels of activity relative to the size of the portfolio. The decline in exits in 2012 was even more significant; there were only 61 exits in our 2012 sample, down from the 85 exits in 2011 and almost on par with 2010 levels. While the proportion of trade buyers increased, only nine of the 24 exits that went to trade were bought by European companies; 10 were sold to US buyers and five to strategic buyers from Asia Pacific and the rest of the world.
“At under 40 per cent of exits to European trade buyers, this is the lowest percentage ever recorded in our study, a clear demonstration of the lack of confidence European corporates experienced in pursuing M&A strategies. On the flip side, the proportion of trade exits that went to US and buyers from the rest of the world increased in 2012. This is just one sign that international buyers are an important source of exits for PE, while European buyers continue to hold back,” says Date.
In contrast with 2010 and 2011– when sales to other PE houses accounted for nearly half of exits – secondary buyouts reduced in 2012 as a proportion of exits to just over 35 per cent. After a fall in number in 2011, creditor exits increased in 2012 as the prolonged downturn took its toll on some businesses in the portfolio.
By investment, some areas are more active than others. The EUR150m to EUR500m entry enterprise value (EV) bracket grew its portfolio by 27 per cent between 2007 and 2012. However, when moving up the investment size spectrum, growth in the portfolio reduces. Investments with an entry EV of between EUR500m and EUR1bn grew by 11 per cent in the same period, but the two brackets above – EUR1bn to EUR2bn and over EUR2bn – recorded declines of four per cent and 13 per cent respectively. And it is these parts of the market have been hardest hit.
Harry Nicholson, Ernst & Young’s PE partner, says: “While most acute in the over EUR2bn investments, across the portfolio the low level of exits presents a challenge for PE. Making new investments is obviously important, but PE will need to increase its focus on realising the backlog of companies to be exited to return capital to investors. Exit rates need to increase two to four fold over the coming few years if this overhang is to be is managed successfully. In today’s M&A market, the bar has been raised in terms of completing exits. PE still has more to do to ready their businesses for sale, widen the buyer pool and create competitive tension.”
Nevertheless, low exit activity should not be interpreted as an indicator of the PE portfolio’s overall health. Analysis of companies in the portfolio shows there is value to be generated if PE can find ways of selling businesses. While according to the data, 20 per cent may generate a less than 1x equity return; over 40 per cent are expected to achieve investment returns of at least 2x equity invested.
While the industry will continue to face difficult challenges, the study signals that PE’s focus on absolute value growth through investing capital and hands-on involvement in its portfolio companies does create better and more valuable businesses.
Over a third of PE-backed businesses in our sample doubled entry EV by the time they came to exit. The study shows that nearly half of all exits in the sample grew 100 to 200 per cent over their entry EV while 34 per cent of the sample grew more than 200 per cent.
Although 19 per cent of the businesses in the study were less valuable at exit, the vast majority of PE-backed businesses were clearly more valuable at exit than they were when acquired. Annual EBITDA growth in these businesses also continued to outpace public company benchmarks – even those businesses that came through the recession and were exited between 2010 and 2012.
Says Nicholson: “The objective of PE investments is to see growth in business value. The data shows that in aggregate PE is successful in this, and value growth is achieved in the majority of investments by productivity growth, employment growth and investment."
Date concludes: “As we move through 2013, it is unlikely that the market will be there to help with the challenges that the PE industry faces. The IPO window cannot be relied on and European corporate buyers remain uncertain. PE needs to beat the wider M&A market by stimulating strategic interest from trade buyers, particularly those outside Europe. Generating successful exits will be the key to securing future funding from investors, who can only be patient for so long. However, the data shows that the PE model remains resilient despite the challenges it faces.”
