The dealmaking environment may be complex, as prices stay high and sourcing difficult, but US PE investors continue to deploy capital. And signs that the industry continues to evolve in response to broader cyclical factors—investing more heavily in tech companies and raising larger funds—remain intact.

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2017 Analyst Note: Where Can PE Firms Find Attractive Valuations?

Some key data points to focus on in our latest US PE Breakdown, sponsored by Merrill Corporation:

  • PE fundraising is mirroring the 2007 boom, on pace to surpass $220 billion
  • The median debt percentage has grown to 56.3%, as high-yield bonds drop to a three-year low
  • Exits by PE firms seem to be subsiding even further, entering a new normal

Introduction

Key takeaways

  • PE fundraising through June 2017 has mirrored that of the 2007 boom. Capital commitments are on pace to surpass $220 billion, half of which are committed to mega-funds with more than $5 billion in commitments.
  • After clocking in at 10.7x in 2016, US M&A EBITDA multiples have regressed slightly in the first half of the year, to 10.5x. Meanwhile, the median debt percentage has increased to 56.3% as high-yield bond spreads reached a three-year low.
  • Deal flow held steady in 2Q 2017, though it is still slightly below last year’s pace. Across the US, 866 deals were completed, totaling $151.1 billion in value.
  • PE exits continued their slowdown with $102.3 billion in exit value over 474 deals. The industry’s selling rate appears to be entering a new normal following the sale of excess company inventory from the last recession.

In the following pages, we’ll examine each phase of the industry’s cycle and investigate the factors most relevant to investors. Beginning this quarter, we’ve included estimates on top of the usual deal flow data that our readers are accustomed to. Due to the nature of private market data, information often does not become available until well after a transaction takes place, so shifts tend to occur over time. With these new estimates, we aim to provide an even more accurate picture of the private markets. Please see the methodology page of this report for more details.

We hope this report is useful in your practice. Please feel free to contact us at [email protected] with any questions or comments.

DYLAN E. COX

Analyst

PE players remain active

Overview

Despite a complex environment, PE funds still deploying capital

PE deal flow held steady in 2Q 2017, though it is still slightly below last year’s pace. Across the US, 866 deals were completed, totaling $151.1 billion in value (estimated). Aided by lower high-yield credit spreads and armed with $545.5 billion in dry powder, PE firms are continuing to deploy capital, despite high multiples and the oftmentioned dearth of quality targets.

The IT sector has become particularly popular in recent quarters, accounting for 19% of deals through June 2017. Tech companies often provide high-growth opportunities in an otherwise underwhelming—in terms of GDP growth—economic landscape. On the other hand, the energy sector continues to be hamstrung by concerns about price fluctuations and a global supply glut. The sector has made up just 4% of all PE deals this year, the lowest since we started tracking the data in 2006.

US PE

Multiples remain close to seven-year high

After clocking in at a post-crisis high of 10.7x in 2016, US M&A EBITDA multiples have regressed slightly in the first half of the year, to 10.5x. Though not quite at last year’s level, current market pricing certainly poses a challenge for PE deal teams. Meanwhile, high-yield credit spreads are at a three-year low, meaning there is plenty of appetite for buyout loans. The median debt percentage has risen accordingly, to 56.3% of enterprise value, well above the 50.0% recorded last year. The median debt/ EBITDA ratio has also increased, to 5.9x through June 2017. The increased leverage gives future PE returns more upside, but also more risk in the face of the downturn that some soon expect.

US PE

Prices and owner-bias curb PE megadeals

Despite growing fund sizes, PE firms often find it difficult to compete with the bidding power of the largest corporate acquirers. Making things more difficult, company founders sometimes prefer to sell to a competitor rather than a buyout shop, believing the former will be a better steward of the organization they’ve spent a lifetime building. Recent examples include Whole Foods CEO John Mackey reportedly requesting an offer from Amazon while also entertaining bids from at least four PE firms, as well as the PE-backed grocery chain Albertsons. Mackey, a vocal opponent of both venture capital and hedge funds, no doubt preferred a takeover offer from his eventual acquirer. This type of bias, as well as the sheer size of corporate balance sheets, especially in such a high-priced environment, has contributed to fewer PE megadeals in the first half of the year. PE firms closed just five deals worth at least $2.5 billion through June, on pace for the fewest of any year since 2012 and well-behind last year’s count of 20.

US PE

Have we reached peak add-on?

After climbing nearly every year since 2006, add-ons continued to make up nearly two-thirds (64%) of buyout activity in the first half of 2017. Though these transactions are a useful way to accomplish multiple arbitrage, we may soon reach a ceiling for the prevalence of this type of deal as each platform reaches an average size of nearly three portfolio companies (two add-ons plus the original platform). With a median hold time of 5.4 years across all exit types, sponsors only have so much time to tack-on new businesses before converting into a larger conglomerate and returning money to limited partners. Further, the larger check sizes necessitated by the mega-funds raised in the last few years entail the pool of investable companies will shrink.

US PE

Upper-market volume surges

Deals by size & sector

US PE

US PE

Volume healthy, value down

Exits

Exits continue downward trend

PE exits continued the downward trend that began in 2015, with $85.75 billion in exit value over 470 deals through the first half of the year. This decrease is driven largely by the cyclical nature of the industry and a reduction in company inventory over the last few years, as PE sponsors exited companies held through the last recession. We saw greater activity in 2Q than in 1Q but volume is still down 26% from 2Q 2016. Overall exit value is on track to be down 46.5% this year if the pace holds flat.

US PE

Financial services has been the strongest-performing sector in terms of exits. $15.7 billion has been exited through the first half of the year, nearly as much as in all of 2016. With no extraordinary deal value in financial services at the four to six-year investment

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