The last two years have been very good for investors in private equity. The industry has distributed large amounts to its investors, $444 billion in 2014 and $561 billion in 2013. More importantly, it distributed in 2014 again much more, $177 billion, than it invested (Preqin). These large distributions combined with double digit median returns since 2000 should make everybody happy...
The last two years have been very good for investors in private equity. The industry has distributed large amounts to its investors, $444 billion in 2014 and $561 billion in 2013. More importantly, it distributed in 2014 again much more, $177 billion, than it invested (Preqin). These large distributions combined with double digit median returns since 2000 should make everybody happy. So private equity seems to have weathered the storm of the financial crisis well and is deservedly high on the agenda
of many investors today. The question these investors should ask is whether all this will last. The excessive swings appear to be a thing of the past. The industry has become bigger; fund managers have also become more careful and a little more boring. When growing up private equity has gone through some roller coaster rides, raising money and spending it in sudden bursts. The industry has become more mature and much larger and as a result less volatile. It has also become more patient and feels less pressure to spend the money if conditions appear less favorable.
Private equity has grown significantly over the last 30 years and growth is now slowing down. Superimposed on this growth there are various cycles. After a few years of good returns much more money flows into this market too fast putting pressure on private equity managers to pay higher prices and put it too work rapidly. Returns come down and the cycle starts again. In addition private equity is correlated with many other financial markets even though this may not show up immediately. In today’s more mature market surviving managers are getting bigger and few new players are entering the market. In 2014, only 4% of the total number of managers were new entrants according to Preqin, the lowest percentage ever since 1980. In 2000 during the dotcom
bubble when everybody wanted to become a venture capitalist, this number was over 25%. The world according to Preqin has close to 6’000 private equity managers today. Taking the Preqin numbers we arrive at an average of assets under management per fund manager of $646million in 2014. This is double the size of an average manager 10 years ago, when it was $320 million. There is also less pressure on individual managers to invest. The amount available for investment per manager, dry powder in private equity speak, has remained fairly stable over the last 10 years at $150-200 million. However, the value and the number of unrealized investments, the industry’s inventory, have increased by more than 160% during this period. There are several explanations; there is no doubt still an overhang from the binge period prior to the Lehman collapse. Furthermore there is less pressure on more mature managers to raise new money and invest it quickly, as they manage a series of funds which together generate generous management fees. To be fair most have also learned lessons from their rock and roll youth and are a little more disciplined when prices are high.
This does not take away the fact that very low interest rates, favorable stock markets and an increased inflow of funds into the industry have started to push up prices again. According to the Centre for Management Buyout Research enterprise values in 2014 were around 10.9 times EBITDA (Earnings Before Interest Depreciation and Amortization) for companies valued at more than €100 million. For smaller companies with an equity value between €15 – 150 million enterprise values moved from a low
of 6.6 to 8 times EBITDA in 2014 according to Geneva-based Argos Soditic. Other indicators of a market heating up are high secondary prices and shorter fundraising periods. The private equity market will always be cyclical as there is a near-continuous mismatch between funds raised and investment opportunities, sometimes too many sometimes too little. The industry will never get it perfectly right, but its well-established and experienced practitioners are more balanced today.