Representing 64% of all US buyout activity through the end of September, add-ons have never before constituted such a lofty proportion of private equity investing.
Part of that is a statistical quirk. As the volume of buyouts has slid while investors generally maintained the pace of adding on, relative proportion was bound to increase. But, as noted over the past couple of years, the primary drivers for the growing add-on rate have been consistent: a competitive dealmaking environment, a shrinking supply of quality opportunities for original platform buys, and relatively costly transaction multiples.
It’s difficult to gauge how much longer this confluence of factors may persist. For one, economic growth could finally bump upward significantly if there’s a sizable shift in fiscal policy, which may very well occur in the wake of the US presidential election. That could embolden PE investors to make riskier plays predicated on at least a short period of stronger growth.
But at the same time, the quality of platform opportunities within the market isn’t simply going to surge over the next few quarters and reverse the trend toward add-ons. Within the US lower middle market, aging baby boomers looking to sell and retire may contribute to a steady stream of companies going up for sale, but that’s just one of the few positive factors when it comes to the supply of businesses being brought to market.
Sector-specific drivers could help, as well—e.g. the level of fragmentation in healthcare services or segments prone to consolidation as efficiencies of scale trump organic growth opportunities. However, in general, the level of adding on looks set to continue for the foreseeable future, with only one potentially detracting factor. For in-demand platform extensions, multiples have been climbing, which could eventually depress even the prevalence of adding on and further slow the overall buyout cycle.
Note: This column was previously published in The Lead Left.
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Article by Garrett James Black, PitchBook