All exit options are open for private equity-backed businesses in 2015. Expect acquisitions, corporate carve-outs, IPOs and the continuing carousel of secondary and tertiary transactions. It means that PE firms can count on the competition hotting-up for quality assets, while the management teams of high-growth companies should be in a strong position to make operational improvements and increase market share.
The general opinion among those in private equity is that businesses should be able to build on the momentum that was gained in 2014. Criticaleye spoke to a range of executives, advisors and PE houses to identify the five trends that will shape the space in the year ahead:
1) A Mountain of Dry Powder
The biggest factor impacting the PE space in 2015 will be the availability of capital. As a result of quantitative easing programmes in North America and Europe, as well as the increasing influence of Asian funds, the market has been flooded with capital, which is inflating the price of assets.
Bridget Walsh, Head of Private Equity for UK & Ireland and Greater China Business Services Leader at EY, comments: “The industry now has $470 billion of dry powder. This is unprecedented… for the industry but investors are certainly choosy about selecting quality assets. That said, I think we’ll have a very busy start to the year, the capital is there to do deals and there’s going to be a lot more M&A activity – we’ve seen some large corporate divestments announced.”
With competition increasing, sponsors may have to work a little harder. Simon Tilley, Managing Director of corporate finance firm DC Advisory, says: “The valuation gap is still there, which is frustrating deal-making. Firms might need to be a bit more creative: it might be that they have to pay a little bit more for an opportunity that really is in their sweet spot.”
For Steve Parkin, CEO of 3i backed FMCG concern Mayborn Group, management teams looking for investment need to demonstrate a growth trajectory and a strategy that’s resilient to macro volatility. “We’ve got an election in the UK, the dollar rate is tumbling down and there’s instability in some of the Eurozone.
“Private equity firms will be looking for quality of earnings and businesses that can show they are able to weather some of these challenging conditions. Very high-performing assets will go at a decent multiple but those that are in that mushy middle will continue to struggle.”
2) An International Outlook
A global perspective is sweeping through the PE space and, while international expansion is hard to get right, the scope to open up new markets is unrivalled. Bridget comments: “If you take European GDP levels, top line growth isn’t going to be achieved by simply looking at the domestic market. I think management teams need to be very mindful of emerging markets and operational improvements.”
Gary Favell, CEO of Bathstore, which is backed by American billionaire Warren Stephens, says: “More and more PE houses are looking for that international development, a brand that travels internationally. We’re working to get into either the emerging markets or those markets that are very liquid: the Arab States, India and so on.”
Of course, there are plenty of opportunities across Europe too. Justin Ash, CEO of Bridgepoint backed Oasis Healthcare, a provider of dental care in the UK and Ireland, says: “More than ever, international expansion [should] be seen a good opportunity. Obviously it’s complicated, so it’s not to be taken for granted, but our acquisition of Smiles Dental in 2014 took us into Ireland and has proved to be very successful. It’s good to have a market with different dynamics.
“Our market is a growth market in most parts of the world and we tend to benefit from environments where there has been a lack of consolidation and a lack of branding. So for us, that’s what a new market needs to have to make it attractive.”
3) Where’s the Exit?
Both trade and secondary exit options are open, and despite a subdued Q4 the IPO market is likely to pick up once again. This means 2015 will be a year of decision-making because there is no longer any excuse for firms to ‘sit’ on assets.
Paul Brennan, Chairman of OnApp, a cloud infrastructure software provider which is backed by LDC, says: “I think everyone’s looking at what is a possible exit strategy or the dilution strategy in the context of where the market is. PE houses are asking, ‘You know what, do we double down re-invest, or do we look at perhaps letting other people lead the next round of funding?’
“I’m not seeing everyone going: ‘Oh, we don’t want to invest,’ but they’re not all saying: ‘Yes, let’s put loads of money into these businesses,’ either.”
Martin Balaam, CEO of Jigsaw24, an IT services company backed by Northedge Capital, adds: “There will be pressure on PE houses to start to show some realised gains before they look to raise their next funds towards the back end of 2015, so yes I would anticipate a few exits. I also feel that there is more corporate activity starting to happen so there will be an increasing number of trade sales.”
Foreign buyers are definitely on the lookout for deals and they’re prepared to pay a fulsome price. Charlie Johnstone, Partner at private equity firm ECI, says: “If you are a business in North America… looking for a launch pad in Europe, you understand the language, the legal system is not too dissimilar and there’s a huge degree of trust that what you’re investing in is what you think it is. The UK is a great place to be buying a business and that will continue.
“You’ve then got US private equity firms coming over here that pay 13 times for a business and think that’s cheap. We’re looking at the same business and would probably pay ten times, but they’d have to pay 15 in the US. That arbitrage, from their point of view, is available, and we’ll see more of that. As such, we know we have to match them on the best investment opportunities.”
Following a bumper year for sponsor backed IPOs, raising over $104 billion (Q3 2014 YTD), the public markets are set to remain a credible exit route. Tim Farazmand, Managing Director of mid-market private equity firm LDC and Chairman of the British Venture Capital Association, says: “The IPO market has been buoyant for much of 2014, with a number of PE-backed companies floating, including one of our own portfolio, Fever Tree, which is a premium mixers business.
“More recently, economic concerns have weighed down on the IPO market but hopefully, with a more benign economic environment… it will open up again.”
4) Taking the Sustainable Approach
As a result of slow growth and potential buyers taking extra care with due diligence, PE firms have had to embrace a more mature, long-term approach to strategy. Gary says: “I don’t think you can go in anymore and just say, ‘Look, we’ll take the cost out, strip it back and then move it on.’ People are coming in looking for a sustainable plan.
“You’ve got to be able to show that the business you want to sell has a robust platform for growth, fully supported by both a strategic and operational plan.”
For sponsors, it’s a case of becoming more creative around the services they provide. “There is certainly a longer-term view in the industry,” says Bridget. “A number of private equity funds have invested in good operational teams which means they can identify assets that may be operationally challenged… and can really help turn it around.”
According to Charlie, ECI has had particular success with this approach. It set up a Commercial Team six-years ago which acts as resource for management teams to draw on when they need guidance with difficult operational dilemmas: “The number of projects they run for our portfolio is huge and the results have been impressive – putting our growth at 20 per cent per annum, that’s an underlying earnings growth well above GDP.”
5) All Important Alignment
Given it’s not so easy for financial engineering to gain a quick win, many PE firms have had to adjust to that longer-term view on how to drive growth. It’s made the role of the chairman even more important in terms of managing expectations around the exit between the executives and sponsor.
Paul comments: “When I’m talking to PE houses about my role as a chairman, what I am finding is they are increasingly asking about how I can be that bridge between the management team and the PE house.
“They are very happy for me to go in there and try to help bring them and the management team together. I think chairmen need to be more hands-on now than they have ever had to in the past.”
Sam Ferguson, Group CEO and President of EDM, an information management provider which is backed by LDC, says: “Too many people do deals just because somebody comes along with money…
“My experience tells me that you have to be able to work as a team, and… you must share common directional agreement. There’s nothing more frustrating than having aspirations or a certain direction for [the company] but not getting the backing from the investment group.”
Expect 2015 to be a busy year for private equity. Firms have a huge quantity of funds to invest and they will be on the hunt for buy-outs and acquisitions. Global trade buyers will also be in the mix, seeking to capitalise on cheaper finance. As Simon says: “2015 will be progressive – there’s more confidence and hopefully we can continue to build on that.”
I hope to see you soon