US Private Equity Activity Slides-Excluding Dell-EMC, Deal Value Falls 29% QoQ by PitchBook
A continued decline for US Private Equity
Nothing’s changed. That phrase can more or less sum up the path in which private equity has moved over recent quarters. Through the third quarter of the year, transaction counts have fallen and while total capital invested at first sight looks high, a significant proportion of that comes from one deal, so we don’t think we can take that aggregate figure as an adequate representation of the entire market’s general sentiment.
In today’s context, dealmakers have to be more prudent. The capital to get deals done isn’t an issue but the exit markets are dryer and lenders are more skeptical around the quality of, and the level at which they can lend to certain companies. Further, there is a natural and cyclical element to the slow manner in which the market has moved. Over recent years, a general partner could pull the trigger on a few deals with the expectation that the general economy and market was more accommodating to help underpin growth. Today, top-line revenue is increasingly difficult to drive and earnings growth has remained sluggish, so many managers are focused on building “recession-proof” businesses that can sustain any external shocks we may get in the coming years, whether that be domestic or foreign.
That trend will remain in place. And despite some limited partners cutting allocations, the overall industry will continue to attract significant levels of patient capital that can be put to work over time.
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Deal value has plateaued
Through the third quarter of 2016, nothing has changed in terms of the trend around total private equity deal volume. Activity has consistently legged lower quarter over quarter, yet if we look at aggregate transaction value, the numbers can be a bit deceiving. Three quarters through the year, total capital invested came in at $484 billion across 2,477 completed deals, which puts 2016 deal value on pace to come in relatively flat with 2015 and volume set to come in down nearly 18% YoY. On a quarterly basis, the macro market landscape looks even more perplexing. 3Q saw $171 billion invested across 662 transactions and while that volume figure represents a quarterly drop of more than 26%, that aggregate transaction value number points to a near 10% jump over what we saw in 2Q, a figure we don’t think speaks to the true dynamic of the market.
During the back half of 2015, we framed our analysis to exclude the $55 billion Kraft-Heinz merger. That deal was a clear outlier; as the diligence process in transactions of that magnitude typically spans
multiple quarters, we thought it didn’t adequately represent the sentiment of the market during 2H 2015. Last quarter, we had a similar situation, driven by the $60 billion Silver Lakebacked Dell-EMC combination. If we look at the data without the Dell-EMC transaction, we get a total 3Q deal value figure of just $111 billion, which reflects a rather considerable 29% QoQ drop in deal value. From a corporate M&A perspective, we certainly note the strategic need to put together larger, blockbustertype deals in today’s slow-moving macro environment. Yet historically, we haven’t seen pure private equity transactions come in at the level of either the Kraft- Heinz or Dell-EMC deals. In fact, if we look at all private equity transactions over $20 billion dating back to 2000, the closest deals in terms of total enterprise value occurred in 2007, which encompassed the KKR-backed buy of Energy Future Holdings ($48.1 billion) and the Blackstone-backed acquisition of Equity Office Properties ($39 billion). Thus, although 2016 deal value is on pace to come in flat with what we saw in 2015, we think a more accurate interpretation of both 2015 and 2016 is a market that has for the most part seen both value and volume move more in lockstep than what the data depicts at first glance.
Overall, dealmakers have continued to look lower down the value spectrum to find relative value as multiples remain historically high. Despite the drop off in deal counts across the board, we’ve seen transactions valued under $100 million represent the largest proportion of completed deals since 2009. Three quarters through 2016, an aggregate of 1,750 deals were closed at an enterprise value of under $100 million, amounting to over 70% of all completed deals. This also speaks further to the seemingly never-ending trend of private equity players needing to utilize the buy-and-build strategy to help blend down purchase multiples in an expensive market. To that point, 2016 has seen add-on deals account for the highest percentage of private equity deals we’ve tracked in at least a decade (64%).
Valuations continue to climb
Deal multiples & debt levels
Starting last quarter, 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 clarification, valuation-to-EBITDA multiples through 3Q 2016 are at 11.2x—the highest level since at least 2010 and up from 10.2x in 2015.
To this point, 2016 has seen an uptick in private investment in the healthcare and IT sectors, both of which tend to trade at higher EV/EBITDA multiples due to their high perceived potential for growth. As more and more deal activity moves toward these highgrowth and high-multiple sectors, some of the change we see may not be in the valuations themselves, but in the migration of PEGs to these industries. 15% of private equity deals thus far in 2016 have been in the healthcare industry, and an additional 17% have taken place in IT, both the highest figures in our datasets.
As we have touched on in prior editions of this report, the wider lack of earnings growth and ample capital availability have also contributed to the current record-high multiple environment across the M&A sphere. According to Factset, companies in the S&P 500 held a combined cash and short-term investment balance of $1.46 trillion at the end of July 2016—the second highest total in at least 10 years, allowing companies to use their balance sheets to grow inorganically and possibly accept lower returns in the short term.
Transitioning to debt usage, through the third quarter, the median debt percentage on private equity and M&A transactions was 48.4% of enterprise value (EV). This figure is down from what we reported a quarter ago, but the broader trend is that more and more equity is being used to complete deals. While low compared to EV, median debt usage is at 5.4x EBITDA, down from 2013-2015, but still relatively high on a historical basis.
See the full report below.