The music has yet to stop for dealmakers, as buyers and sellers pull out all the stops to find and win good transactions in a historically high-price environment.
“We’re not in the 8th or 9th inning of a sellers’ market,” said Justin Abelow, managing director of Houlihan Lokey’s financial-sponsors group. “We’re in the 12th or 13th inning. It’s also unclear to me what would change this. The economy seems to be running along fine and animal spirits are high.”
It may be the strongest sellers’ market in years, but Reeve Waud, who heads Waud Capital Partners, disagrees with the “let’s sell everything” attitude that some of his peers have.
“I’d argue that the world is awash in liquidity and that capital is seeking a return,” Waud, founder and managing partner, said. “The world growth is accelerating and the world economy is getting better. This may be, for a period of time, the new normal. It’s been the new normal since the Great Recession.”
Waud should know. His middle-market PE firm closed 26 deals this year, including four platforms and 22 add-ons.
Michael Weisser, who as a partner at Kirkland & Ellis represents sponsors and their portfolio companies, is confident sponsors will always find a way to thrive, whether it’s traditional buy and sell, doing distressed deals, minority investments or follow-on acquisitions.
“There’s always potential headwinds for private equity that people like to talk about,” Weisser said, citing frothy debt markets, North Korea, tax reform, the political environment and Brexit as examples over the past few years.
“Yet here we are at the end of 2017 and once again private equity continues to flourish and be a very successful business model.”
This year has already produced about $184 billion of disclosed PE deal value in the U.S. through Dec. 10, according to Thomson Reuters data. That exceeds $170 billion, $117 billion and $112 billion of reported value in 2016, 2015 and 2014, respectively, the data shows.
One of the largest PE deals announced in Q4 by a U.S.-based firm was Global Infrastructure Partners’ takeout of renewable-energy giant Equis Energy for $5 billion including debt. CIC Capital Corp and Public Sector Pension Investment Board were also investors in the deal.
In other high-profile PE activity this year, a Bain Capital-led consortium in September shelled out $18 billion for Toshiba Corp’s semiconductor business.
Blackstone Group also made a big wager in tech, striking the largest sponsor-led deal in Q1, when it agreed to pay $4.8 billion for Aon’s technology-enabled benefits and HR unit. Vista Equity Partners followed with its own $4.8 billion tech deal when it agreed to buy Canadian fintech DH Corp.
Retail was by no means the most active sector but produced some big check sizes.
Sycamore Partners, an avid buyer of retail businesses, made its biggest deal to date, betting $6.9 billion on Staples in a deal that closed in September. Panera Bread also scored a big price tag. Krispy Kreme owner JAB Holdings reached a deal in April to take the soup-and-sandwich chain private for about $7.5 billion including debt.
In healthcare, New Mountain Capital’s $6.4 billion deal in May for lab-supplies company VWR Corp was a standout. Another high profile deal: the fusion of contract-research organization INC Research with its PE-backed peer, inVentiv. The deal valued inVentiv, whose backers Advent International and Thomas H. Lee Partners maintained a minority investment in the company, at about $4.6 billion.
An ever-widening buyer community eager to strike deals—- which in addition to traditional PE includes family offices, sovereign-wealth funds, pension funds and direct LP investments — continues to support a high-price deal environment.
The latest numbers from Pitchbook show the average enterprise-value-to-EBITDA PE deal multiple remained at about 10.5x at the end of Q3, in line with 2016 levels. That’s up from EBITDA multiples of 9.9x in 2015 and 9.4x in 2014, according to Pitchbook.
“We all know that multiples are increasing,” Abelow said. “The question is: multiples of what? We’re seeing parties be more aggressive about the types of things that they’re pro-forming in EBITDA adjustments, in both the debt markets and M&A markets.”
Abelow said it’s not unusual for a pro forma EBITDA figure to be 25 percent to 30 percent greater in value. Some buyers are very skeptical and simply will not play in processes marketing a heavily adjusted EBITDA figure, whereas others with a certain conviction or particular angle continue to participate, he said.
Sponsors certainly have huge sums of fresh capital to put to work, but it’s the debt markets that continue to serve as one of the biggest drivers of today’s historically high prices, said Christopher Brothers, managing partner at Solace Capital Partners, which provides flexible debt and equity for established businesses facing complex situations.
Deal multiples reflect leverage multiples, with average debt-to-EBITDA multiples in the middle market at about 5.8x for the 2017 fiscal year, Pitchbook said.
“You have fear and optimism that constantly plays against each other in investing,” Brothers said. “We’re in a part of the cycle where optimism is far outweighing fear. That usually happens at very late stages in the cycle, whether in equity or credit.”
Brothers noted the market is about 105 months into a bull run from an equity perspective, the longest-duration bull market since 1926, other than the bull market of 1990.
“You have this demand to put credit to work,” he said. “You have a lot of capital that has been raised through private debt funds, and some through the BDCs, and because of that, middle-market leverage is at the highest level since 2007.”
Spreads have also tightened, Brothers noted. Unitranche financing, one of today’s most popular financing structures of choice, has tightened by about 40 basis points to 50 basis points, he estimated.
A rising price environment also begs the question as to how sponsors are able to generate the same returns when they’re paying significantly more.
Waud’s answer: “Everything you do has to be process-driven. It has to be disciplined. And most importantly, it has to be replicable. The only way to be successful long-term is to back the best assets.”
In other words, you can’t have a strategy that’s built around finding ways to buy assets cheaper, Waud said.
Waud, for its part, has what the investment professional described as a highly systematic approach composed of four key components: research, human capital, business development and operations.
Creating opportunities doesn’t always come easily. Jeremy Swan, managing principal of CohnReznick’s financial sponsors and financial services practice, characterized proprietary deals as “the golden dreams of PE firms but the hardest deals to find.”
That said, the trend around preemption is also leading to significantly more outreach from sponsors directly to private companies, Swan said. Sponsors are executing a much more extensive due-diligence process that expands beyond accounting and tax efforts and takes a deeper look at things like people, IT and finance functions.
“More firms are starting to build this diligence earlier to show that they’re serious; to show the target that they’re really putting some skin in the game,” he said.
As intermediaries continue to matchmake well ahead of auctions, working various networks is vital.
“You need to make sure that every single banker, lawyer and consultant who’s out there thinks of you when they have an opportunity that fits,” Waud said.
What to watch in 2018
Experts by and large described 2018 as more of the same or an acceleration of the same in terms of PE deal trends.
As Swan put it, that’s much to do with the fact that 2017 is ending with about the same level of uncertainty as last year.
“Here we are almost 12 months later and virtually nothing has gotten done out of DC,” Swan said. “We’re in a situation that looks very similar to the end of last year. Debt is readily available and valuations are still high. There’s still a significant amount of demand for quality assets and a lot of cash sitting on the sidelines.”
If anything gets done, it will be tax reform, as Republicans are racing to pass a final bill by year’s end. Experts believe pending tax changes could have serious implications for leveraged buyouts, though to what extent is debatable.
“This has been the biggest puzzle to me this year,” Houlihan’s Abelow said, referring to the uncertainty around tax reform. “There have been some things mooted about that could have serious repercussions, but everybody is acting like its business as usual, and it’s a little bit weird to me.”
Certain years over the past decade have seen a tremendous amount of deal activity around year-end because of a fear that tax rates would rise, whereas in other years conflicting views among buyers and sellers have thwarted activity, he noted.
While it appears that most of today’s leveraged companies won’t face a materially greater tax burden if the House tax bill is passed, a cottage industry could emerge around balance-sheet restructurings, Abelow said.
“There’s likely to be a revaluation around cyclical and non-cyclical businesses,” Abelow said, predicting the former would face worsened risk.