Private equity strikes as strategics lull
Overall US M&A activity dropped in 2016 compared with 2015. However, private equity buyouts kept pace with the previous year. Figures for 2016 show that there were 1,030 buyouts over the period, up from the 969 deals recorded in 2015. Value was up marginally as well, from US$159 billion to US$159.4 billion. TMT remained the most popular target sector in terms of both volume and value, with 243 deals worth US$55.7 billion. Large buyouts in the space included Apollo and Searchlight Capital Partners acquiring IT group Rackspace for US$4.1 billion and Apollo buying ADT, a home security systems developer, for US$12.3 billion. Industrials and chemicals, a sector undergoing significant consolidation and an ideal candidate for private equity investment, was the next most popular sector with 186 deals worth US$24.5 billion. Business services, a private equity favorite, delivered 158 deals worth US$20.3 billion. The consumer sector, in which there were 122 deals worth US$11.2 billion, also proved popular.
One reason for sustained private equity activity is that many strategic buyers have taken a step back from M&A to consolidate deals closed in 2015. Private equity firms have benefitted as there is less competition for deals from strategics. It also means corporates are focusing on core business and divesting non-core divisions. This has ensured a steady flow of potential targets for buyout firms, such as Thomson Reuters’ US$3.6 billion sale of its IP and science business to Onex Corporation and Baring Private Equity Asia. “Strategics may see the party coming to an end, or just see too many storm clouds on the horizon and are more cautious,” says Oliver Brahmst, a partner at White & Case. For strategics, M&A is not the only avenue for growth. Sponsors are in the business of doing deals. They may gripe over high valuations, but in the end they have to keep hunting for good investments and their investors expect it.” Favorable financing markets have supported buyout activity too. “The lending market has been frothy enough to allow PE shops to make acquisitions, even at higher price points,” says Carolyn Vardi, a partner at White & Case.
Flashing the cash New buyout activity has been sustained by the large sums of dry powder that still need to be deployed. According to Preqin, the amount of capital available to private equity fund managers is now sitting at a record high of US$839 billion. “The bottom line for private equity firms is that they have a ton of cash that many of them need to put to work. Obviously they need to make returns and get out to raise money for the next fund, but they also don’t want to run into a situation where they’ve got to return capital commitments,” says Matthew Kautz, a partner at White & Case. Even though deal multiples continue to look punchy, firms have been able to continue deploying funds in a competitive way by being more flexible in their approach. Buyout firms no longer rely exclusively on leverage and control to generate returns. Instead, private equity firms are taking minority stakes in targets and focusing on operational improvement and investing in smaller platform companies with a view to expanding them into bigger businesses. This helps them to compete with the high valuations cash-rich strategic buyers are paying. This extended horizon is seen in several deals. For instance, a key part of Platinum Equity’s successful US$4 billion bid for Emerson Network Power, a non-core IT infrastructure group owned by Missouri-based Emerson, was the scope it gave management to make longer-term plays. Private equity backing has freed the business to build entire data centers for clients, which had been more difficult as part of a manufacturing-focused parent company.
One reason for sustained private equity activity is that many strategic buyers have taken a step back from M&A
“Sponsors are expanding the type of investments they will do,” Brahmst says. “Sponsors are not averse to investing in minority stakes any more and in different places in the capital structure. Also, club deals, with memberships ranging from sponsor exclusive to sponsors and strategics combinations have started to appear more and more over the past couple of years.” Silver Lake, for example, acquired the Ultimate Fighting Championship (UFC) franchise in a deal through a bolt-on acquisition by portfolio company IMG Worldwide. Brahmst says sponsors have also adapted to a more competitive market by widening the products available to investors. “Firms are expanding their offerings by raising industry-specific funds and introducing funds with different investment horizons to meet the demand for longer-term capital, albeit at lower rates of return,” Brahmst says. Vardi says buyout firms have also focused on pre-empting formal processes in order to secure deal flow and gain a competitive advantage. “A number of private equity shops have ratcheted up their efforts to create personal and strong relationships with CEOs of smaller companies so they can parlay those relationships into opportunities for first (proprietary) looks before those companies are put up for auction,” Vardi says. “During the past year there was definitely an uptick in pre-emptive offers. As soon as there was a whiff in the air that a company was going to be put up for auction, a private equity shop would come and try and snap it up.”
Exit stage left? Although buyout activity held its level, exit activity dropped when compared to 2015. Exit volumes for 2016 fell to 956 from 963 in the same period last year, while value rose from US$232.1 billion to US$233.2 billion. “The market is still seller-friendly, but the balance between buyouts and exits has become a little more even. Maybe for the past two or three years, 60 percent to 70 percent of the deals for most firms would have been exits, with maybe one or two buys out of 10 deals. In 2016 I think it was a much more even split,” Kautz says. On the exit front, healthcare-related companies delivered good outcomes for private equity firms. Madison Dearborn Partners sold medical supplies group Sage Products to technology company Stryker for US$2.8 billion and Veritas Capital sold Truven Health Analytics to IBM for twice the US$1.3 billion it had paid for the company in 2012. “This is still a very favorable seller’s market, and private equity is still well-positioned to make some strong exits,” Brahmst says.
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Private equity firms have maintained their investment pace in 2016 even though overall M&A activity has slowed