Private Equity's Outperformance
PE portfolio companies generate more cash-flow growth; secondary buyouts drive deal flow
July 21, 2008
Portfolio companies of private equity firms have surpassed the financial performance of publicly-listed companies for the third straight year, according to Ernst & Young.
The accounting and professional services advisory firm's latest private equity-related study, Beyond the Credit Crunch, was launched in mid-January, and marked its third annual report on private equity value creation. Ernst & Young conducted interviews with buyout executives behind the 100 largest global private equity realizations in 2007, and examined the private investment business in light of the credit market retrenchment and economic uncertainty.
E&Y's examination included 44 transactions spread between Canada and the US, as well as 53 realizations in continental Europe and the UK, and tree transactions from Asia, a market where financial sponsors and law firms have fortified operations over the past year.
Transactions in the range of $500 million to $1 billion turned out to be the best performing private equity investments, demonstrating the study's finding that smaller transactions proved to generate the strongest increase in enterprise value.
Additionally, E&Y's report determined that middle-market transactions may offer the most promising investment opportunities in coming months because mid-sized deals are likely to receive a better reception in the credit market. "Growth businesses with good track records, particularly those in non-cyclical sectors, will attract financing," the report stated.
It also noted that a private equity-owned company's enterprise value, or worth from its combined equity value and debt, increased by 24%, whereas that of publicly-traded comparable companies only posted a 9% increase in enterprise value.
In the $500 million to $1 billion range, the enterprise valuation of portfolio companies increased 30% whereas public comparables increased 13%.
When it came to enterprise valuation growth on a geographic basis, companies in France and Germany each posted 29% increases, compared with 9% and 16% growth for public companies in each country, respectively.
Technology and telecommunications companies proved to be the best performing players with 30% enterprise value growth against 10% enterprise value growth rates for comparable public technology and telecommunications businesses.
Organic revenue growth was the primary growth engine at private equity-owned businesses over add-on acquisitions, says Ernst & Young principal John Vester.
"The primary driver and single biggest source of value creation is organic revenue growth," he says, adding that private equity firm executives are "doing the same kinds of things sophisticated corporate managers are doing to improve businesses."
Eighty-four percent of the companies studied pursued organic growth strategies, the report noted.
Because most financial buyers employ teams of operating executives, generally ex-corporate managers from chief executives to chief financial officers, that help oversee or hone the business operations of portfolio companies, the finding isn't entirely unexpected.
Another finding that wasn't too surprising was that the secondary buyout, or acquisition of one private equity-owned company by another private equity firm, proved to be a common exit avenue last year.
Secondary sales accounted for 32% of North American 2007 exits, while secondary buyouts in Europe generated 29% of exits last year, the same percentage as 2006.
Despite some negative public perception, the data attest that companies sold via secondary buyouts perform well in the care of a second financial buyer with an average enterprise value growth rate of 27%. As the report states: "Put simply, after owning them for several years, it is clear that PE investors sold better businesses than they had acquired."
The secondary buyout market doesn't appear to be waning any time soon, either.
"We see the trends are going more towards secondary exits," says Vester.
The Ebitda growth of companies studied also improved under private equity ownership. E&Y discovered these businesses were ahead of comparable publicly-traded entities by 33%.
Besides revenue and Ebitda increases, E&Y found that employee growth in private equity-owned businesses outperformed employee growth in public companies.
Another interesting finding from the study revolved around value creation and transaction type. Private equity purchases of corporate business units via divestitures proved to be the best performers from an enterprise value growth standpoint, producing a 25% growth metric. Carve outs scored eight percentage points more than acquisitions of public companies, which E&Y discovered were the poorest performing deals.
According to E&Y, despite macro-economic uncertainty and a possible global retraction in profit growth, the proven ability of private equity to outpace public companies on key metrics "strongly suggests that the industry can manage a slowdown and position itself to advantage when the [M&A] market returns."
(c) 2008 Investment Dealers' Digest and SourceMedia, Inc. All Rights Reserved.
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