PRIVATE EYE, BY DAVID TOLL
Here’s the breakdown of deals examined by RCP for the period 2004 to 2014:
- Proprietary deals: 40 percent to 50 percent.
- Limited/broken-auction deals: 30 percent to 40 percent.
- Full-auction deals: 20 percent.
During that 10-year period, the percentage of proprietary declined, limited/broken-auction deals rose, and full-auction deals held steady. Not surprisingly, full auctions were far more common in the sale of bigger companies: Roughly half of deals involving companies with enterprise values above $150 million sold in full auctions last year.
It is worth noting that RCP said its numbers may reflect some bias due to some sponsors reporting non-proprietary deals as proprietary.
Proprietary deals bring undeniable advantages to sponsors, including greater certainty that they will close. But looking at just a subset of its dataset, 1,500 realized transactions since 2000, RCP found the median gross return on invested capital to be fairly consistent, right around 2.6x, regardless of whether the deal started life as a proprietary transaction, limited/broken auction, or full auction. At the same time, the firm found the standard deviation of ROIC of realized proprietary deals to be higher than that for limited/broken auctions, which in turn was higher than that of full-auction deals. RCP speculates that intermediaries may help screen out companies that have more underlying problems, imbuing their deals with less downside risk.
“If you ignore this element of risk in proprietary deals, you’re missing a really important aspect of what you’re investing in,” said Ross Koenig, an associate in research at RCP.
Koenig said that while on a median basis sponsors may not get compensated for the added risk they take in proprietary deals, they’re “probably” getting compensated on an average basis thanks to the performance of high-flyers. Koenig along with Managing Principal Tom Danis presented results of the firm’s study in March at the Buyouts East conference, produced by Buyouts Insider, publisher of Buyouts Magazine.
All told, the RCP database consists of more than 15,000 private equity transactions from 1985 to present, of which about 7,000 have been fully realized. To collect the data the firm tracks the activities of some 1,500 North American fund managers, most of which raised less than $2 billion for their latest fund. The firm devotes signficant resources to what it describes as a “proprietary and confidential database.” Three full-time people oversee the effort, which involves gathering data from a wide variety of sources, including PPMs, annual meetings, in-person meetings with sponsors, and third-party data sources such as Preqin, CapitalIQ and Cambridge Associates.
Below are some other highlights of the Koenig and Danis presentation:
- It matters what you pay. The more focused study of 1,500 realized transactions since 2000 found a strong association between purchase price and ROIC, although purchase price is just one of many factors influencing ROIC. Case in point: If you pay 6x EBITDA for a company instead of 7x you can expect a 2x ROIC instead of 1.8x. The sensitivity of ROIC to price depends on the industry. From least sensitive to most sensitive, according to RCP: energy, health care, information technology, industrials and consumer companies.
- EBITDA multiples paid by sponsors have risen gradually from the mid-5x range to the upper 6x range from 2002 to 2014, with a dip forming in the wake of the financial crisis of 2008. Notably, RCP found that prices of health care companies have climbed at an especially steep rate over the last three years, to a median of 7.8x EBITDA in 2014. At the same time, prices of industrial companies have remained relatively flat, in the 6.0x to 6.3x range.
- Bigger companies command a premium price. Since 2010, Koenig said in the interview, companies with enterprise values above $150 million have broadly speaking been selling in the mid-7x range on a median basis, while those smaller than that sell in the low-6x range. Koenig said that once a business reaches $150 million in enterprise value it has an “inherent higher sophistication” and is “humming at a whole different level than when it was a mom-and-pop at a lower enterprise value.”
- It matters who you buy from. RCP found the median gross ROIC for companies bought from financial sponsors to be about a half turn lower than for companies bought from enterpreneurs/founders or as part of corporate carevouts, roughly 2.5x vs. 3.0x. That said, it also found higher standard deviations in ROIC for companies bought from enterpreneurs/founders and corporate carveouts, suggesting those deals carry more risk. Last year, financial sponsors were the sellers in about a quarter of the deals tracked by RCP, a figure that is up from 10 years ago but that has remained fairly steady over the last five years or so.