U.S. PE Volume Falls, Lowest Deal Value Since 2Q 2013 by PitchBook
A continued decline for U.S. PE
As we’ve moved halfway through 2016, the private equity world continues to see activity decline at an elevated pace. PE-backed inventory remains full of relatively new portfolio companies, and with that, we’ve also seen exit trends decline rapidly. The aforementioned trends can look fairly imposing on a chart, but as the industry as a whole finds itself in limbo, maybe we can address it as a reorganization period.
Growth prospects are dim, and as sponsors look to source attractive opportunities, the base case of where they model out transactions should probably incorporate a more negative outlook. Borrowing costs remain low for many targets, yet the credit window can also be narrower for many deals that would have been better received over the first part of 2015, prior to the volatility we’ve seen impact most asset classes over recent quarters. So as managers look to assess the quality of the deals on their table, in addition to the financing options utilizable to both get deals done and sustain their businesses through an external economic shock, things are naturally moving slower, which we don’t think is necessarily a bad thing.
It will take an extended period for PE to work its way through this cycle. While traditional buyout numbers might not look as robust as they have over the past few years, the current environment has provided late-stage opportunities for niche secondaries, distressed or sector-focused managers to enter the market and provide limited partners with additional avenues to continue deploying capital to an asset class that has outperformed for them historically. The continued resilience of PE fundraising numbers also speaks to the patience and understanding of these investors, so in a world where central-bank-fueled capital markets have shown increasing signs of irregular behavior, LPs appear set to lock up capital and wait it out with PE.
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Trends remain the same
Buoyed by the $14 billion take private of Keurig Green Mountain, the first quarter of 2016 saw total PE deal value rise on a quarterly basis, despite the pronounced decline in volume we observed during the same period. However, as we’ve moved through the year, 2Q 2016 has brought activity back to the trends we previously anticipated, with both aggregate deal value and volume sliding. PE sponsors deployed nearly $135 billion last quarter across 719 completed transactions, representing (quarter-over-quarter) QoQ drops of 18% and 14%, respectively. If we back out and look at the numbers from a midyear perspective, the data lends itself to a more nuanced analysis, with aggregate deal value trends actually coming in a bit stronger than expected. Driven by a series of transactions involving publicly traded targets, the first half of 2016 saw over $298 billion worth of deals close, representing a 12% decline relative to the back half of 2015 and a slight increase over the same period last year. If we back out the $55 billion Kraft-Heinz mega merger that closed in early July 2015, however, 1H 2016 deal value would actually come in higher by close to 6% relative to 2H 2015, an interesting statistic given that transactions the size of Kraft-Heinz aren’t frequent occurrences.
Global economic and growth forecasts remain tepid at best. Factset estimates that 2Q S&P 500 earnings will drop by 5.6%, marking the first time corporate earnings have experienced five consecutive quarters of YoY declines. Although that estimate will likely come down once all companies in the index report final quarterly earnings, that number is a downward revision from a previously expected earnings slide of just under 3% in March. Looking at economic growth estimates, the World Bank forecasts that global real GDP will grow at 2.4% through 2016 (revised down from 2.9% in January), with domestic real GDP set to increase at just 1.9% (shifted lower from 2.8%).
The above estimates continue to paint a sluggish macro picture for dealmakers. PE managers also face additional domestic headwinds including prospective wage growth pressures to both portfolio and target companies, along with a persistently strong US dollar that has only added to an increasingly impactful trend of slowing emerging-market demand. Despite public equities recently reaching record highs, much of the movement in the stock market has been undoubtedly fueled by an era of cheap debt and accommodative QE policies. Nothing new. Yet as publicly traded companies continue to have difficulty finding the right levers to pull to achieve acceptable growth, especially with the rise of activist investors paying a closer eye to management teams, an opportunity does appear to be arising for PE to intervene. Looking at the top 10 transactions of 2H 2015, eight were take-privates, with one PE-backed corporate divestiture. With a tremendous amount of capital yet to be deployed, and the stock of PE-backed inventory remaining relatively new, writing a bigger check in a worthwhile publicly traded acquisition could continue to interest PE at a heightened clip.
In this report edition, we combined our PE and M&A transaction multiple datasets to capture a more comprehensive and accurate view of the deal markets in terms of pricing and debt usage. With that caveat, EV/EBITDA multiples midway through 2016 came in at approximately 11.3x, a whole turn higher than what we saw throughout 2015. As deal volume continues to plummet moving out of the most recent buyout boom, the distinct split in the level of quality transactions coming to market has become a bit more apparent, which has had a pronounced impact on multiples. Delving deeper into the debt-to-equity mix dealmakers are employing, we’ve noticed a couple trends that speak to the nuances an uncertain global landscape can induce. The median equity-to-EBITDA multiple in 1H 2016 came in at 5.8x, a significant jump from the 4.5x figure we saw last year, and by far the largest number we’ve seen since at least 2010. Concurrently, the median debt percentage has also moved lower rapidly, coming in at just under 49%. According to data released by the Federal Reserve Bank of St. Louis, US nonfinancial corporate debt levels have risen to over $5.6 trillion as of the end of 1Q 2016, with more than $2.1 trillion of that coming after 2008. The rising increase in corporate credit levels has also held true across foreign and emerging economies; with many PE-backed businesses operating at a multinational level, the financial stresses experienced abroad can manifest domestically. Regardless of what potential negative catalysts there may be, any external shocks could affect sponsors from two primary angles: the first being the simple ability to service existing debt and the second the ability to secure debt financing from banks when looking to complete larger transactions. Therefore, the consistent decline in median debt percentages speaks to the wariness of many dealmakers, leading to a more risk-averse approach to deal structuring. As the bulk of PE deals occur in the middle market, many dealmakers are still able to secure the covenant-lite packages they need to complete deals within the parameters they model out, but they too could be looking to operate at a baseline that includes less debt, in turn reducing the risk their portfolio companies could experience in the face of future external headwinds.