Are private equity portfolio companies worth more than their public market rivals at point of sale?
“Our study counters the continuing myth that cheap debt and cost-cutting are the principal drivers of private equity success,” said Simon Perry, E&Y’s global head of private equity.
The lack of available debt of any kind and any magnitude has prompted many to suggest that private equity’s main calling card – outperforming the more transparent public markets – no longer applies in a credit-crunched market. Inability to load up the leverage on the buy-side (or overload if you’re a critic or Standard & Poor’s report writer) would inevitably impact on internal rates of return at exit.
Perry, though, suggests that private equity’s other selling point – operational improvement – comes into play here. With fewer opportunities to sell on an asset early, otherwise known as the quick flip, private equity firms will be forced to hold on to portfolio companies for nearer the advertised three to five years, meaning an increased focus on streamlining processes, trimming the fat and hiring new talent. An improved business should equate to a decent money multiple in the long run.
From a fund investors’ point of view, however, a three times money multiple in year two generates a bigger IRR than a six times multiple in year four. The numbers work out at 73% compared with 57%, according to Coller Capital’s internal rate of return (IRR) metrics.
The report is unlikely to muffle private equity’s critics, either, especially in the UK, where the report found the least evidence of outperformance with only a 14% rise in value. The concern has been that private equity and its investors reap the benefits of any inherent value and ensuing operation improvement: they gobble up the profits and capitalise on asset-stripping fire sales, leaving devalued husks unfit for return to the public markets.
Recent speculation that Blackstone might be considering making a return to
Can Blackstone be blamed for what happens after a company leaves its ownership? Do private equity firms create value? Will the credit crunch make a mockery of private equity’s claims to be a creator of value across all points of the cycle or highlight its resilience and adaptability? Whatever the reports say, the jury is still out – for now at least.