Back to School: High multiples, lack of quality assets to bedevil PE in 2018: survey

  • Economy, dry-powder levels to drive deal flow
  • Operational focus most popular adaptation
  • Continued emphasis on proprietary deal sourcing

High transaction multiples and a lack of quality assets in the market are the most significant challenges facing PE this year, a PitchBook survey shows.

The research firm in October and November collected forecasts for 2018 from dozens of dealmakers. Access to financing was ranked as the least important challenge, unsurprisingly, with interest rates having been so persistently low and non-bank lenders ascendant since the financial crisis.

The state of the economy and dry-powder levels were expected to be the biggest deal-flow drivers. More than $1 trillion of undeployed capital has accumulated at PE firms, Preqin says, a landmark amount that will pressure deal teams to make acquisitions, even as it pushes up already elevated pricing.

The most popular adaptation to the high-multiple, low-growth environment is “heightened focus on operational improvements,” followed by “increased use of [add-ons]” and “new deal sourcing tactics.” (According to PitchBook, the median EBITDA multiple of an add-on since 2006 is 8.4x, compared with 9x for platform buyouts.) Almost 20 percent expressed a willingness simply to accept lower returns.

Nearly seven of 10 respondents expect to use more equity in transactions this year, a “particularly significant” finding “given the readily available cov-lite debt financing for more PE deals.” PitchBook pointed to “ever increasing valuations and changes to interest deductibility” as motivating factors, and noted that increased equity contributions could ultimately lead to lower returns.

When it comes to borrowing, three-quarters reported that favorable terms were most important to their firms, while 19 percent said low rates. Reflecting the ease of refinancing, a majority (63.2 percent) said they were willing and able to close a deal without a completed debt package, in the expectation of working out funding afterwards.

Traditional banks are still the most common source of debt financing, with 40 percent saying they’ll use them. That proportion is smaller than last year’s. Mezzanine lenders and corporate financial sponsors gained ground, mentioned by 31 percent and 21 percent, respectively.

The most important deal-sourcing strategy is reportedly PE professionals’ own networks, followed by industry events and personal research. Since finding valuable assets is expected to be so difficult, PitchBook observes, “it’s safe to say that virtually all managers will continue to tout their access to proprietary deal flow as being a competitive advantage.”

Action Item: Check out PitchBook’s 2018 PE Crystal Ball Report here.

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