Portfolio companies show strength in a weak M&A market

Hey gang! LP reporter Gregg Gethard here with this week’s column.

It’s a very murky economic picture right now. Real GDP growth came in at a tepid gain of 1.6 percent for the first quarter. Meanwhile, the Fed remains hesitant on whether it will reduce interest rates in the months ahead.

And yet, portfolio company performance overall looks strong – as shown by the most recent Lincoln Private Market Index, which tracks changes in the enterprise value of more than 5,000 private companies mostly held by private equity funds.

The index hit a record high in Q1 2024, showing the continued strength in private company valuations. The strong enterprise values of companies in the index was driven by their ability to deliver results despite headwinds, as 63 percent of the companies Lincoln tracks demonstrated EBITDA growth in the quarter.

Portfolio companies are also optimistic for the next year in planning their budgets for 2024, Lincoln International managing director Ron Kahn tells me. Companies surveyed by Lincoln are projecting revenue growth of 10.3 percent with EBITDA increasing by 11.5 percent.

These are both steep increases from projections for their 2023 budgets, Kahn says.

The rosy outlook comes even as more portfolio companies face steeper interest payments than they did two years ago – cash that flows from a company’s wallet into the hands of a lender.

According to Kahn, private companies are doing a good job managing costs in this tricky environment. And, as they budget, companies are holding back more on capital expenditures.

“This could have more of a long-term effect than a short-term effect on a company’s growth,” Kahn said.

But all of this begs the question: where are the exits? If PE-backed companies are demonstrating such strength in an uncertain, challenging environment, why does no one seem to want to buy them?

Higher rates have a lot to do with it – it’s simple math – GPs bought at what were likely loftier valuations, using cheaper debt, and are now faced with the prospect of selling at tighter valuations to buyers who have to use more expensive debt.

But Kahn says another factor is also at play: a simple lack of confidence in the market.

“Our backlog of M&A is higher today than it has been in maybe the entire history of our company. It seems that the due diligence process is going on for longer and longer and the bid/ask spread is still wide. So, deals are being postponed or pushed back,” Kahn says.

Fingers crossed that people realize how successful portfolio companies are navigating these tough waters – and that distributions start to flow back to investors.

As we’ve mentioned many times on Buyouts, while deal activity will inevitably come back because GPs have uncalled capital they have to spend within a certain period of time, exits are a different story.

Strong performance will go a long way to helping open up those paths to liquidity again.

Anyone want to talk about anything with me? I’d love to spill the tea regarding LP news or PE in general. But we can especially talk about how awesome my Philadelphia Phillies are looking right now or how much fun the New York Knicks have been. Or we can mourn the loss of the great music producer Steve Albini. Either way, hit me up on LinkedIn or at Gregg.g@pei.group.