U.S. PE Deal Count Drops To Lowest Level In Two Years by PitchBook
Introduction
U.S. private equity appears to be experiencing somewhat of a slump. The third quarter of 2015 saw deal counts slide to the lowest level since 2Q 2013, while capital invested —excluding the massive merger of Heinz with Kraft Foods—also declined to a total unseen since early 2013. PE investors simply do not seem to have much of an appetite for the buy side these days, quite understandably. High valuations have been a talking point for some time now, many buyers reporting that deal prices are often too rich for their taste. Even though alternative lenders and the Fed are keeping access to debt fairly inexpensive and wide open for now—particularly in the middle market, where the bulk of PE action is nowadays—investors are justifiably wary of the long term.
U.S. PE is in the early stages of a slump on the buy side, but still selling actively.
Where firms aren’t quite as cautious, however, is in taking advantage of the seller’s market for as long as it persists. The defining phrase of the PE selling spree has been Leon Black’s statement that Apollo Global was “selling everything that is not nailed down.” As exit tallies have slid since a high in 4Q 2014, exit avenues may be narrowing slowly, even if total value is still strong, so PE’s continued push to sell this year makes sense. Since corporate M&A has been the primary exit route for PE-backed holdings throughout 2015, how much longer the seller’s market will be sustained by the current M&A boom is uncertain. M&A count and volume diminished from 5,322 deals worth $505 billion in 2Q to 4,436 for $457 billion in 3Q. Ongoing economic and market volatility outside of the U.S. is affecting buyers’ exuberance. Those issues also affect not only PE sales but also PE’s prospective targets, not to mention possibilities for organic portfolio growth.
But in times of trouble, there’s always a silver lining, as sectors such as energy that are hit particularly hard begin producing targets ripe for PE investment. PE firms may be biding their time when it comes to cutting deals, but they are still collecting commitments, planning to capitalize on opportunities presented by the current economic tumult. Accordingly, even if we are seeing the early stages of a slump, it may not hold for long, especially as its causes differ from what precipitated the last crash. We hope the information and data in this report are useful and help inform your decision-making process in the coming quarters.
Overview
U.S. PE deal flow continued to slide moving through 3Q. Total invested capital came in at $153.7 billion; this number, however, includes the massive Berkshire Hathaway and 3G Capital-backed merger of Heinz and Kraft Foods Group, which was valued at approximately $45 billion (excluding assumed debt). We view that deal as an outlier from current levels; removing it from capital invested totals yields about $109 billion across 777 deals. 3Q total value was down over 18% relative to the $133.6 billion tally of 2Q, 30% on a yearly basis, again without taking the Heinz-Kraft merger into account. Total counts for the quarter were down about 13% QoQ and 19% YoY, without the merger.
As we’ve noted in previous reports, the buyout resurgence of the past few years is losing fuel. Total volume is still heightened in comparison to the quarters prior to 2H 2013, yet counts have been dropping consistently in recent quarters. Capital invested through buyouts thus far into 2015 is also depressed. Public markets have begun to stutter as global economic concerns moved further into the spotlight. With that volatility and elevated valuations in both public and private markets, PE shops are increasingly wary of paying multiples that will affect their ability to control future exits. This risk-averse behavior is beginning to enter the market, in turn driving counts, capital invested and values lower.
Accordingly, investors are turning to add-on acquisitions, which have remained the preferred deal type through 2015, making up 47% of all completed transactions. As a percentage of buyouts, add-ons have accounted for a record 62% thus far into the year. While firms still have the capital to close new deals, they need to exit market-ready portfolio companies at a value that still provides an adequate return. PE firms are consequently adding value to existing portfolio companies, looking to protect exit multiples in anticipation of the eventual decline of the seller’s market.
Still flush with LP commitments, PE investors keep looking for value, but fairly priced transactions aren’t often to be found in the current frothy environment. While counts were down across all deal types in 3Q, PE growth transactions remained relatively flat on a consecutive basis, with 155 during the period. Still down relative to 1Q and previous quarters, the flat performance compared to 2Q is interesting. GPs are forced to either chase deals at heightened multiples, where the risk-adjusted returns are less favorable, or find other avenues to generate acceptable returns, such as the lower middle market. Staying on the sidelines for some time can be an option, but for investors looking to stay active, a noncontrolling stake in growing businesses can be profitable. Growth investments can help funds employ dry powder to generate a modest return and provide a foothold intothe company, rather than no return or a loss from overpriced transactions.
Counts are likely to continue dropping, if sedately, moving forward. Volume should still be healthy relative to a few years past, but the peak of the PE buying cycle may already be past. Capital is available to deploy in the right deals, especially as access to debt remains open for companies with healthy balance sheets, but moderation will be increasingly in vogue for a while.
Deal Multiples & Debt Levels
Valuations appear to have peaked in 2014. Transaction multiples and debt levels continued to move lower in 3Q, similar to what we’ve seen play out QoQ this year. Thus far into 2015, median EBITDA multiples for buyouts are down considerably to 8.3x, driven by a few key factors. The quality of the typical company in the market may have declined. Attractive businesses, especially distressed assets nursed back to health during the post-recession buyout boom, were likely bought last year when valuations continued to creep higher. Lower-quality companies helps explain why, in our 3Q 2015 Deal Multiples & Trends Report, over 20% of dealmakers anticipated flat or decreasing revenues for a year.
Looking at debt levels, median debt percentage used to back transactions has remained just under 60%, which we haven’t seen since 2011. Debt-to-EBITDA multiples in 2015 are sitting at 5.0x, lower than the 6.6x and 6.7x recorded in 2014 and 2013, respectively. Cheap debt in recent years has definitely supported the buyout boom, yet there may be a caveat to this positive effect manifesting. With interest rates as low as they’ve been in recent years, many non-PE investors have moved to the high-yield bond market in search for yield. PE target companies are frequently significant issuers into that market, as uncertainties around their projected cash flows result in their debt receiving below investment-grade status. Concerns have surfaced regarding corporate earnings, and the junk bond market has swelled in size over the past half-decade.
Consequently, speculative-grade bonds experienced negative price action in recent months, especially as a rate hike looms. If the Fed begins to raise rates over the next year, these bonds could experience a sell off, hiking their own yield. Prospective new issues would become more expensive and attractive refinancings difficult to come by. As a result, the decline in relative debt use by PE is likely prudent.
