August 23, 2018
By Andrew Cristinzio, US Private Equity Leader
Armed with record amounts of capital, private equity firms are increasingly looking to invest it in different types of deals. Longer hold periods. New partners. Alternative structures. Along with more traditional transactions, all of these have become fair game as PE firms pursue solid returns in an era of high valuations.
There’s certainly enough ammunition for acquisitions – more than $1 trillion in capital at PE firms at the end of the second quarter, according to data from Preqin. Fundraising has slowed but is still healthy by historical standards. Many firms have closed the largest funds they’ve ever raised, and the abundant dry powder will enable them to be more creative with deals in the months ahead.
This outlook comes as PE deals remain ahead of last year’s pace. Even with a modest second quarter, the first half of this year saw a 4% increase in the number of acquisitions from the same period in 2017, according to a PwC analysis of Thomson Reuters data. The 1,900 US PE deals in the first six months have set a pace that would eclipse the record number of transactions in 2017. Combined with lower corporate deal volume, PE deals have become a larger percentage of total US deal volume. Compared to 20% or less for much of the past decade, PE deals made up 24% of last year’s volume and 27% of deals in the first half of 2018. The value of announced PE deals was up 36%, with six megadeals – transactions of at least $5 billion – accounting for more than 40% of total PE deal value. That’s twice as many megadeals as in the first half of 2017.
More targets on the horizon?
The technology and consumer sectors have seen the most deal volume by far, with about half of transactions touching those areas. Tech has especially surged, representing 30% of first-half 2018 volume, up from 22% last year. Within the sector, software as a service (SaaS) companies remain very attractive to buyers, and cybersecurity also is hot. And some tech companies specialize in certain sectors, such as finance, healthcare or consumer, giving PE firms an opportunity to build concentration in those areas.
We should see more targets from corporate carve-outs, which are growing in scale. Regulatory requirements around M&A and more proactive corporate governance could accelerate divestitures. Meanwhile, large companies are re-evaluating their portfolios and determining where they can shed businesses that aren’t leading their markets. Divestitures from large industrial corporations are often appealing to PE buyers, and large technology and pharmaceutical companies also have businesses that draw interest. Whether it’s voluntary or not, each divestiture expands the pool of PE deal targets.
In addition, PE firms that hold high-quality assets, if not tempted by an energetic IPO market, could make them available to other firms that have an abundance of dry powder. We’ve seen an increase in secondary buyouts by PE and expect that to continue.
Alternative paths help transform private equity
With high valuations and competitive pricing dominating the deals landscape, PE firms are looking more and more at non-traditional ways to capture value in a transaction:
- Some firms have opted to acquire smaller assets at lower multiples. In some sectors, such as technology, firms may consider a transaction where they take equity and don’t fully control the target, giving up the typical leverage.
- In larger deals, PEs have enlisted sovereign wealth funds or pension funds to join an investment. Those funds may be limited partners in the PE firm and could be preferable to another PE partner when it comes to filling a hole in the capital structure for a large deal. That’s always been an option but is now happening on a bigger scale.
- More firms are considering longer holding periods that allow more time to create value and generate adequate returns. Those returns may not be as high as other funds, but that model likely will endure.
- Firms are increasingly picking spots where they can go deep with industry focus, developing expertise that’s leveraged across the portfolio. As the generalist approach fades, most high-end firms have built dedicated sector teams, while middle-market firms often focus on one or two places where they can get to know the space well.
By knowing the participants and building a network within a sector, PE buyers can take more initiative instead of reacting to a deal opportunity. That’s more important following the recent fundraising, as firms are ready to put capital into play and may need to move quickly on a target.
The competition is tough. But between plentiful cash, still-low interest rates and favorable debt markets, I don’t see many PE buyers staying on the sidelines as 2018 rolls into 2019.