Private Equity’s new deal-making puzzle
Deal making is the heart of private equity (PE) and there will be plenty to be done in the months ahead. A wave of PE-owned assets acquired during the prerecession boom years is slated for sale, setting up opportunities for sponsor-to-sponsor transactions. And even in the most mature PE markets, general partners (GPs) have not fully penetrated the population of companies that are good candidates for PE ownership. As we explain in Bain & Company’s latest edition of the Global Private Equity Report, deal count could increase this year, but deal value will not move up significantly unless big public-to-private transactions stage an unexpected comeback.
Riding the favourable tailwinds of 2013, many indicators are moving in the right direction on the investment front going into 2014. Stronger fund raising replenished PE funds, providing GPs with fresh capital to finance new rounds of deal making. Debt markets have rarely been so open and eager to finance new deals, but the year ahead will not be all smooth sailing. GPs will find themselves confronting familiar challenges; in combination with robust equity and debt markets, mountains of PE uninvested capital will keep asset valuations high and competition for deals stiff.
Fund-raising success in 2013 was a refreshing change from previous years, giving many GPs an infusion of new money to replenish the older vintages they had finally managed to put to work. Nearly all of the capital from fund vintages dating back to 2007 or earlier has been invested. As 2014 began, global buyout and growth funds were sitting on $427 billion in dry powder from the 2008 vintage or later. Of this, better than 80 per cent was in funds from vintages since 2011 – well within their investment period – and more than one third was in a 2013 vintage fund.
Dry powder for buyout and growth funds increased across the globe in 2013. In Western Europe, North America and other developed markets, the addition of new money was a major reversal of the trend underway since 2009, as GPs in the mature economies steadily chipped away at the wall of capital they struggled to invest. In the emerging markets, the inflow of fresh funds in 2013 piled on top of the dry powder that had rapidly accumulated for more than a decade. By the beginning of 2014, buyout and growth capital in the hands of emerging market funds had increased at a ten per cent clip compounded annually since 2009 to $77.5bn.
The build up of new dry powder directly under the control of GPs will light a fire under competition for deals in 2014, but another factor could fan the competitive flames even higher – ‘shadow capital’ controlled by big institutional investors. These investors are putting capital to work beyond the traditional limited partner-GP fund relationship through a wide variety of arrangements, including co-investments, separate managed accounts, co-sponsorships and some direct investments without the involvement of a GP. Will shadow capital compete with, or disintermediate, PE firms as institutional investors face off with GPs to buy assets? Only a handful of institutional investors have the capabilities needed to compete directly with PE firms for buyouts on a standalone basis. Even the biggest, most adept ones tend to partner with PE firms rather than go directly head-to-head against them for deals. Although, perhaps, it’s not an immediate concern, the role of shadow capital bears watching.
Meanwhile, with fresh capital in their hands, GPs do not feel the acute pressure to invest that hounded them in the years immediately following the financial crisis when the deal market shrank and they were left holding vast sums of dry powder amassed during PE’s prerecession boom years. However, they cannot afford to wait long to find productive ways to use the new money. The recent large capital infusion ensures competition for deals will remain intense. Assuming no change in buyout deal value from last year’s total and that the use of debt to finance new deals remains the same, Bain estimates the $399bn in dry powder currently in the hands of buyout-fund GPs would be sufficient to cover 3.4 years of new deal making.
As we will see in the next instalment of this series of articles, GPs will have to dig deeper to ferret out opportunities that can generate the returns they and their limited partners expect. They will also need to work harder to add value to the assets they acquire to extract real gains from their ownership.
Written by Hugh MacArthur, Graham Elton, Bill Halloran and Suvir Varma, leaders of Bain & Company’s Private Equity Group.