Assessing The PE Deal-Making Environment: EV/Revenue Multiples Surge by PitchBook
Many core fundamentals of the PE deal-making environment have remained unchanged for some time now. High valuations have persisted throughout the year, remaining a primary concern for buyers. Even if volatility in public markets has led to ripples of uncertainty and a decrease in public stocks, how much that will relieve private asset prices still remains to be seen. As regulations tighten, median debt usage remains low, however, even given the size of price tags. That speaks to the level of scrutiny concerning leverage multiples PE firms and lenders remain under, with memories of the financial crisis still potent. It’s worth pointing out that equity proportions have been declining for several quarters now, due in part to sustained high prices. Already having dialed back activity by count in 2Q, general partners are wary of putting too much capital to work chasing inflated valuations.
Potentially depressed returns aren’t the only cause for concern on the buy side; to look at the broader scene, commodity prices remain depressed and global trade volume is down. The strength of the dollar also has sparked worry, especially among PE firms looking to expand larger holdings globally.
To provide a clear overview of the complex PE deal-making environment nowadays, we’ve not only delved deep into the PitchBook Platform for deal metrics, but also surveyed dozens of investment professionals worldwide for their takes. This edition of our PE Deal Multiples & Trends Report includes more responses than ever before, building substantially on our historical survey data. Combined with our proprietary data, our respondents help shed light on many of these issues. What are PE buyers anticipating in terms of revenue? How healthy are the metrics of the companies PE firms are targeting? What’s the balance of equity to debt in a typical deal?
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After two quarters of EV/EBITDA multiples of 5x or more either exceeding or approaching 80% of deals, 2Q 2015 saw temporary relief, although the proportion of multiples exceeding 7.5x stayed steady. Coupling that with the uptick in median EV/EBITDA multiples in the $250 million+ bucket, it’s likely price inflation in the upper middle market is growing, especially given the popularity of the middle market as of late. Overall, EV/EBITDA multiples seem to have declined from 1Q, but that could be a result of EVs expanding and consequently pricing into different size buckets. Between 1Q and 2Q, median EV/revenue multiples surged across the board, supporting that inference. That increase led to the biggest percentage of EV/revenue multiples exceeding 2x yet recorded in this report series—over 40%. With dry powder ample and strategic competition strong, valuations may well stay within that lofty range for some time.
PE firms continued to target companies with fairly healthy fundamentals in 2Q, shown by the proportion of targets with unchanged or increased revenues in the year prior to the deal approaching 90%. As deal-makers looked forward, optimism by and large prevailed, with close to 80% of respondents anticipating an increase in revenue and nearly half predicting a surge of over 10%. That being said, in the last three quarters there has been a small but significant proportion of respondents forecasting no change in revenues for the year following a deal. A small but still larger percentage than we’ve seen since 2012 predicted a decrease in revenues. Stagnant growth and ongoing depressed oil and other commodity prices, not to mention widespread volatility, are likely contributing to this surge of caution. GPs are guarded, wary of fluctuating economic indicators, yet still confident in their operational expertise.
Debt & Equity Levels
At 52%, median debt usage in 2Q marked the third consecutive quarter debt levels stayed quite low compared to 2013 and 2014. Regulatory scrutiny has helped keep leverage down, especially as banks have increasingly shyed away from such risk. Even though non-bank lenders such as BDCs are filling the gap and money remains cheap, PE investors are deploying debt cautiously. Equity and senior debt still make up close to 80% of the average deal amount—even if that is on the lower end of what we’ve seen, it still speaks to moderation. Deal-makers have been particularly moderate with regard to employing equity. The proportion of equity used has been waning for some time now, likely due to buyers’ reluctance to overpay and depress potential returns. In light of the Fed’s decision to leave interest rates unchanged, the flow of inexpensive financing will persist for a little while longer, so there could be an uptick in investors tapping debt markets, but caution is likely to reign still.
Fees & Closing Times
In light of the ongoing industry-wide conversation around current fee practices, the uptick in the number of transactions with fees in 2Q would seem to bely any concerns. From 1Q 2015 to 2Q, the proportion of deals with fees increased by 8%-up from 54%-but the resulting 62% is still considerably below what was common for much of 2012. As the overall trend is still downward and actual fee levels remain low, the quarterly bump is unlikely to indicate much of a shift. Median transaction fees as a percentage of deal size did increase, but remained in the middle of the dataset, while the proportion of monitoring fees to EBITDA stood steady at 3.0%. Fee proportions are by and large plateauing for now, not seeming to decline further; the ongoing debate around fees have yet to exert an effect upon the numbers.
The increase in the size of transaction fees does align with the overall trend of deals taking longer to close. 1Q saw close to 90% of deals taking 10 weeks or longer to close. A return to historical norms was likely, hence the decline from that 90% in 1Q to just over 70% in 2Q. Hypothesizing from a single quarter’s numbers is risky. The overall trend of deals taking longer to close, due in part to heightened due diligence given elevated valuations, still seems to persist across the market.
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