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Bain: Private Equity and Public Market Return Differential Narrowing

Deals won’t be getting any cheaper, consulting firm predicts.

Private equity firms had as much as $1.47 trillion in funds available to invest at the end of 2016, and debt capital was also readily available to bolster their investments. Still, a situation of rising asset prices, together with fierce competition for these assets in an environment overcast with a possibility of an upcoming recession that could drive down prices, made it difficult to close deals, according to an annual global private equity report from Bain & Company. These firms are cautious about whether today’s deals will bring them to their targeted returns. Banks are also wary of financing big deals.

 According to Hugh MacArthur, head of global private equity with the Boston management consulting firm, “Capital superabundance and the tide of recent exits drove dry powder to yet another record high in 2016. Shadow capital in the form of co-investment and co-sponsorship could add another 15% to 20% to that number. While caution about interest rates remains, there is a general expectation that debt will remain affordable. As a result, deals won’t be getting any cheaper.”

 Investors continued to show interest in private equity in 2016, and these firms raised $589 billion globally, just 2% shy of the 2015 total. One 2016 trend to note is the rise in “megabuyout” funds that raised more than $5 billion each, with 11 such funds raising a total of $90 billion. These funds appear particularly appealing to institutional investors who want to deploy large amounts of money into private equity, the management consulting firm reports. 

And an overall decline in the net asset values of buyout firms, as their distributions to investors outpaced their new investments plus the value of their existing holdings, meant that some investors found themselves short of their targeted private equity allocation. For instance, the Washington State Investment Board pension fund found its private equity allocation down to 21% in 2016, from 26% in 2012. This created a positive environment for private equity fundraising in 2016, but the industry is apprehensive that this strong pace cannot last for too long, as a recession and a stalling stock market, for instance, could upset the strong dynamics.  

The buyout market started off slow in 2016, as the Chinese stock market bust, declining oil prices and the uncertainty regarding Brexit in Europe all had an impact. In North America, the market did not recover momentum and the total number of deals for the year was down 24%, with deal value off 16%. In Europe, there was a more moderate drop off.

Bain finds that there is a potential for almost 800 public companies to be taken private in buyouts, but expects a much lower level of actual public-to-private buyouts going by historical activity. While returns on private equity buyouts continue to outshine the returns on public markets, the gap is closing, as it is getting harder for private equity to find outsize returns on undervalued assets in today’s more benign economic environment.

 Private equity investors have also settled into longer holding periods of about five years for their investments, and this state of affairs is likely to endure for the near term. Historically, these firms have held on to assets for three to five years, but this period was pushed up in the aftermath of the financial crisis as firms had to nurse their assets over a slow recovery period, the management consulting firm reports.

In fact, deals that private equity firms were able to quickly flip over, holding onto them for less than three years, made up a mere 18% of private equity buyouts in 2016, compared to a 44% share in 2008.     

 By Poonkulali Thangavelu 

| Christine.Giordano@strategic-i.com | 212-217-6929