Private equity pulls back in 2015
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The challenge of cash-rich corporates and vaulting valuations has led buyout firms to exercise restraint in the first half of the year. The number of private equity buyouts was down to 398 in H1 2015 from 456 H1 2014. Buyout deal value was also down, falling 25 percent year-on-year to US$58 billion.
The figures suggest that financial sponsors are holding back. Investors are still cautious as they emerge from the financial crisis and have balked at high valuations unless they are investing in an asset of exceptional quality.
 
Competition for good companies has also increased, making it tougher for firms to make investments.
“Stock markets have been strong for the better part of 2015, and a number of potential private equity targets have opted for an IPO instead,” says White & Case partner Oliver Brahmst. “We have also seen corporates return to M&A and when a strategic buyer is hell bent on doing a deal, private equity generally has a difficult time being competitive.”
The competition at large-cap PE firms are facing from strategics has had an impact on the activity of mid-market players too. Large-cap buyout houses are increasingly looking to do smaller deals, which has meant that mid-market players are facing tougher and more competitive auctions.
 
In order to compete, firms are focusing more on the operations of potential targets and portfolio companies in order to deliver strong returns when buying companies for high prices. They are also working harder on due diligence in order to identify steps they can take to improve company performance and grow revenues. Buyout firm Clayton, Dubilier and Rice, for example, runs a team of operating partners who all have direct industry experience and focus exclusively on improving company performance. These operating partners, which include former senior Unilever executive Vindi Banga and former General Electric CEO Jack Welch, will work on transactions pre-deal to identify what operational improvements a buyout firm can make if it invests.
 
As Tate Pursell, managing director of US private equity firm Unlimited Horizons, said in a recent interview: “Private equity groups had to change from financial engineering to building value. They had to sharpen their game.” (See the sidebar “Management compensation in a hot M&A market” for details about how these dynamics affect how portfolio company managers are compensated.)
Brahmst adds: “Private equity firms cannot simply rely on financial engineering. They need to focus on operations to increase returns. We see firms acting like quasi-strategic investors by investing in companies, then supporting their add-on acquisitions. It is also still the case that investors will favor a private equity buyer if it reduces the antitrust risk.”
The private equity industry is, however, at the beginning of a new fund cycle, so firms can afford to maintain discipline and refrain from investing for a while.
HEADLINES
Private equity exits down after stellar 2014 Buyout volumes also down High valuations and cash-rich strategic buyers challenge the private equity sector
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