By Hugh MacArthur, Graham Elton, Daniel Haas and Suvir Varma
With public markets strong and asset valuations high, private equity funds took advantage of a seller’s market in 2017. Exit value jumped 8.6%, to $366 billion, and the number of exits increased 3% to 1,063. Sellers saw strength across channels and geographies.
The 2017 data also suggests, however, that PE firms are working harder and longer to create value. As noted in Bain & Company’s recently released Global Private Equity Report 2018, PE-fund portfolios are holding companies for around five years, vs. a median of less than four years a decade ago. Before the global financial crisis, PE firms were exiting around 40% of all buyout-backed deals in less than three years, but more recently those “quick flips” have retreated by half, to around 20%.
That isn’t to say that quick flips aren’t possible in today’s deal markets. Indeed, one successful exit in 2017 was CVC Capital Partners’ $1 billion sale of Paroc Group to Owens Corning after owning it for three years. Quick deals like that one, though, are becoming the exception. In an era of high asset prices and limited future market beta, generating strong returns usually takes more time. Tax reform has also changed the calculus in the US. Under the new law, carry generated from investments held for three years or less will be taxed at the higher ordinary income rate rather than the lower capital gains rate. Previously, the threshold was one year.
When it is time to pull the trigger, PE funds are seeing multiple strong exit channels, most notably sales to strategic acquirers and other PE funds. Corporations with strategic intentions and pockets full of cash continue to be avid buyers of PE assets. For companies like Unilever, buying growth is an essential part of strategy. In 2017, the Anglo-Dutch company quickly expanded its skin-care business in North Asia when it paid $2.7 billion for Carver Korea, a company controlled jointly by Bain Capital and Goldman Sachs since 2016. Crown Castle International roughly doubled its wireless infrastructure business—and produced the year’s biggest buyout-backed exit transaction—when it bought LTS Group Holdings from Berkshire Partners, Abry Partners, Pamlico Capital and HarbourVest for $7.1 billion.
Sellers are also benefiting from the heated competition among PE firms looking to put record amounts of dry powder to work. The second-largest channel for exits by value in 2017 was sponsor-to-sponsor sales, which give the new owner an opportunity to take a company through its next act of value creation. Buyout-backed initial public offering (IPO) activity opened up in 2017 as well, after a particularly poor showing a year earlier. Following heavy volatility in early 2016, the channel benefited from more stable markets globally, especially in North America, where IPO value nearly doubled its 2016 level. One exception was Europe, where the market suffered somewhat from economic uncertainty across the continent and continuing Brexit turbulence.
It’s important to recognize that the top-line IPO exit number isn’t everything when it comes to public exits. An IPO typically makes up only a small portion of a PE firm’s total stake in a company. Due to mandated holding periods and market timing considerations, a firm usually holds a large share of its investment past the initial offering, unwinding it more slowly in follow-on transactions that aren’t counted in the exit numbers. Taken together, global IPO and follow-on value came in at $129 billion in 2017. Of that total, follow-on value amounted to $87 billion, or 67%.
Exit numbers also fail to capture dividend recapitalizations—transactions in which a portfolio company takes on debt, often to fund a dividend for investors. In the US, dividend-related loan issuance to sponsor-backed companies totaled around $42 billion in 2017. The practice is highly dependent on an accommodating debt market. But when the market demand for high-yield paper is strong, it can provide a compelling incentive to borrow capital, take money off the table and de-risk the investment.
More funds are also leaning toward selling a stake in a company while keeping a hand in the game. Often, a company’s upside potential will outlive a PE firm’s payback timeline. These so-called partial exits allow a general partner (GP) to declare victory on a deal and return capital to investors, but still retain a stake in a company that is likely to keep growing and generating returns. Given how hard it is to find new deals and redeploy capital, it is also in the GP’s interest to stay invested in a known quantity.
Barring any unforeseen shock, global economies are expected to continue their expansion in 2018 and perhaps beyond, which likely will mean favorable exit conditions in the near term. But GPs are hardly being complacent. The aging economic cycle suggests these conditions won’t last forever, and PE firms will continue to seek opportunities to lock in their gains sooner rather than later.
Read the full report: Global Private Equity Report 2018
Hugh MacArthur, Graham Elton, Daniel Haas and Suvir Varma are leaders of Bain & Company’s Private Equity practice.
