The Pattern of Private Multiples: Long-Term Strategy for the PE Industry
The steady growth rate of private capital brings long-term change for equity and debt markets.
Throughout 2019, dealmaking levels curbed substantially as PE firms circumvented the market pressures of deal strategies, including add-ons and sale-leasebacks. Despite the untoward pricing environment, middle-market fundraising levels were high, and deal and exit activities rebounded as investors continued to allocate funds at a rapid pace. With fund sizes scaling at an unprecedented pace, deal and exit sizes continue to swell moving forward. From a PE standpoint, these inevitable increases pose uncharted risks in terms of predictability.
One of the most pressing questions worth asking is whether the public and private markets are breaching a long-term reversal in how they value assets. Historically, public assets have demanded higher average valuations. But as valuation multiples fluctuate, the public and private markets have changed fundamentally. This isn’t news: investors pay a premium for more liquidity and transparency, but as valuation multiples fluctuate, the public and private markets have changed fundamentally. Even though public markets have been known to attract massive flows of capital, there is a new appreciation for private markets, in part due to the superabundance of funds that investors have to put into their work.
The flow of capital into private markets is at an all-time high. In the last 20 years, private-market capital has more than doubled the rate of public capital, with no sign of ebbing in the future. Investors have unleashed long-term change in valuation because they’re increasing their allocations to private equity, driving buyout multiples to record amounts. The change is especially poignant in equity contributions, which grew from 4.8x in 2016 to 5.7x in 2019.
Now, investors are cutting bigger checks, bringing higher risks. In order to sidestep these risks, PE firms are relying on downside protections and the use of sale-leasebacks, which increase the potential for multiple arbitrage and minimize the overall purchase price multiple. As a result, companies are bypassing the associated challenges of going public, while the number of companies suitable for take-privates have surged tremendously.
Unsurprisingly, public to private (P2P) activity continues to inflate, with the value of private companies exceeding the value of public companies. Whether dealing with a large take-private transaction or a buyout of a fast-growing private company, PE firms need to rethink the way they operate. A new, stronger emphasis on due diligence is required in order to thoroughly understand the risks and opportunities involved. Additionally, if private multiples continue to soar at unprecedented rates, firms must adjust and realign their value-creation initiatives. A $30 billion acquisition will not succeed with the same scale-up strategy as a $3 billion company, requiring greater investments in due diligence and skills needed to flex the right M&A solutions to ease the pressures of this expensive market.
We continue to see a growing number of public companies going private, and this is likely just the beginning of this trend. Bigger deals require stronger approaches to deal sourcing, screening, diligence, and value-creation. Given the expanding pattern of private multiples, long-term changes in PE investments will begin to emerge at a rate like never before, drawing investors closer to private markets and transforming how equity and debt markets behave. Start taking advantage of right-sized diligence and value-creation plans to enter into this new era gracefully and ready to put your money to work.