China-based Alibaba just did the largest IPO ever at $25 billion and there will be a lot of chest pounding by its early private equity investors (and Yahoo) including Silver Lake, GGV, Goldman Sachs (apparently already an investor in 1999), Fidelity Growth and Venture TDF. Apparently Alibaba also registered the name “Alimama” in case someone wants to marry them, but most people... 

China-based Alibaba just did the largest IPO ever at $25 billion and there will be a lot of chest pounding by its early private equity investors (and Yahoo) including Silver Lake, GGV, Goldman Sachs (apparently already an investor in 1999), Fidelity Growth and Venture TDF. Apparently Alibaba also registered the name “Alimama” in case someone wants to marry them, but most people would now be  happy  to  be  just friends. Alibaba is a fantastic and extreme example  of  the  private  equity  industry doing what it should be doing, which is helping to build a great company with patient capital and returning (much) more money than was invested. The graph below illustrates that over the last 14 years the private equity market absorbed more money than it distributed back to investors and only during    4    years,    2004, 2005, 2011 and 2013 was their net cash flow positive. Like 2013, 2014 will also prove to be a good  year  for distributions.

The reasons  for  this pattern are several.  First of all, the  world’s private equity industry as a whole has grown enormously. During the first 5 years of this century roughly $100 billion was invested each year. During the last few years the annual investment pace has been around $400 billion.

Secondly, to grow a business successfully takes time. Alibaba has  been  extraordinarily  successful  and needed 15 years to get to an IPO. In 1999 its first investors put their money in; it survived the dotcom bust and benefitted also from China’s phenomenal growth. Most private equity investments return money to their investors much sooner than 15 years. Business plans in private equity or venture capital are usually based on 5 years, which matches reality fairly well for buyouts, which on average have seen exits between 4-5 years, even though they have been getting longer and today exits take on average 6 years according to Preqin. Venture capital tends to take longer, recent data from Dow Jones Venture Source show that the median time from first financing to a >$25M M&A event was roughly the 6.2 years for BioPharma and
5.5 years for Software/Consumer Internet in the US. It should be noted that there is a bias in these data towards good investments. Companies that fail are not counted and the so-called “living dead” take much longer, if not forever.

Thirdly, markets are not always receptive to private equity exits. However, in 2013 stock markets have done well and there has been a relatively high number of IPOs. IPOs are highly visible, especially for record breaking Alibaba, but represent only a small percentage of exits. Most exits are still trade sales, whereby companies with a strategic interest, e.g. competitors,  buy  private  equity’s  companies.  Highly priced stock markets drive deal activity at high prices and are associated with more intensive deal activity and exits of the private equity industry. And let us not forget the very favorable market for debt used in private equity, which has never been so cheap and is very available for larger transactions enabling re- financings. Investors thus receive money back but retain ownership.

If investors decide to swamp private equity with money again like they did in 2008 when nearly $800 billion was poured into the industry, it will be difficult to invest all this money wisely and profitably. More will be invested at high prices than comes back. This seems to be happening at the moment, for private equity transactions of more  than  $250  million  enterprise  value,  where  EBITDA  multiples  have shot up to 14x according to PitchBook data. For smaller deals they  have  remained  relatively  stable between 5-7x; this makes sense as most of the money is raised by larger funds, which are fighting over relatively few transactions with a lot of money. In fact the average private equity fund size has never been larger, $520 million, according to our calculation based on Preqin data. If the industry holds onto its investments longer, which seems to be the case, more money will be locked up in private equity. If the current favorable climate for public stocks comes to an end, as it surely will, deal making will be less and private equity will exit less.

In conclusion, private equity will continue to return more money than it invests if the current environment of a relatively stable investment pace, as well as benign public and debt markets continues.

 

Hans van Swaay
Partner
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