2017 saw a significant decline in the volume of Private Equity deals. PitchBook’s 3Q 2017 US Private Equity Breakdown reported an 11% decline in deal volume compared with the same period in 2016. Prequin data shows a similar trend worldwide, with 391 deals completed in Q4 2017, down from 495 in the same period in 2016.
Does this decline in deal volume signal an end to a Private Equity bubble, or is it a sign of the market adapting?
New challenges facing Private Equity
It’s undeniable that the Private Equity world is currently operating in a challenging environment of consistently high valuations and stiff competition.
Valuations are currently at their highest since 2007. Median purchase price is currently at 9.2 times EBITDA globally, and 10.9 times EBITDA in the U.S, and it’s, therefore, harder than ever for investors to find a good deal.
As well as competition from other Private Equity investors, firms are also facing competition from large corporations with equally large cash reserves. Telecoms giant Verzion memorably outbid three of the world’s leading Private Equity firms in the $4.5 billion acquisition of Yahoo in June 2017.
Taking into account these conditions, it’s hardly surprising that fewer deals are completing, as investors struggle to find attractive deals that generate revenue.
Businesses are adapting to the new marketplace
However, the slowdown in deals is not necessarily bad news for the Private Equity world.
As we highlighted in our recent review of 2017, Private Equity fundraising reached record levels last year, indicating the continued popularity and strength of the market.
Rather than signalling the end of a bubble, the decline in deal volume is likely a result of the fact that deals are simply taking longer to complete. Investors are adapting to the new challenges of a more competitive marketplace by taking more care than ever to ensure the long-term value of the assets for sale, slowing down the deal process.
Ensuring value creation is currently a key priority for investors, to ensure returns justify high purchase prices. Investors are therefore involving operational resources earlier on in the deal process, rather than post-close, as is traditional. Midmarket firms are also investing more in operational resources to ensure all opportunities for value creation are flagged.
Digital Due Diligence is a key part of this process, as insights provided through big data and sentiment analysis can provide a thorough interrogation of an asset’s growth strategy in the initial stages of purchase.
Other firms such as Core Equity Partners are responding to these challenges by investing in assets for at least 10 years as part of a 15-year cycle, with the aim of gaining a deeper understanding of the marketplace and therefore securing higher returns.
A greater emphasis on due diligence and ensuring long-term value creation is ultimately an opportunity for the Private Equity world, as it increases the likelihood of stable, long-term returns, and makes for a more sustainable marketplace.
As ever, the winners will be the firms that successfully adapt to this new environment. To ensure the value of an asset is worth the current high purchase prices, investors should prioritise Digital Due Diligence, and involve operational resources as early as possible in the deal process.
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