Two-thirds of the value created at private equity-backed companies can be attributed to operational enhancements and an increase in market multiples, according to research published by fund-of-funds Capital Dynamics and the Center for Entrepreneurial and Financial Studies at the Technical University of Munich.
The study took in 241 firms from between 1989 and 2006, and examined both value creation and cash flow data — which includes enterprise value, equity value, sales, EBITDA, net debt at entry and exit, and interim cash flows.
On average, equity invested increased by 2.72x over the life of the investment (an average of 3.5 years), of which 1.84x is attributed to operational improvements, 0.89x can be accounted for by the use of leverage, while a further 0.88x resulted from positive EBITDA growth. The remainder was almost equally split by free cash flow improvements and multiples growth, with 0.42x and 0.47x respectively.
Looking closely at EBITDA growth, almost 80% of this is made up of sales growth, with just 20% from improved margins.
The study also showed that leverage grew in importance as a driver of value creation in recent years and was 8% higher as a share of value creation between 2001 and 2006 than between 1989 and 2000. Between the two periods, the contribution from EBITDA growth fell by 16%.