Wisconsin co-investment team cautious as deal prices, leverage multiples rise

High deal prices and private equity’s heavy application of debt are cause for concern at State of Wisconsin Investment Board.

While deal flow remains solid, the Wisconsin co-investment team is being “cautious given the current purchase price multiples and debt levels exhibited in the market,” a presentation delivered to its board last week shows.

Wisconsin, which sources frequently cite as a leader among U.S. public pensions in co-investing, committed $115 million to eight new deals last year. The $117 billion retirement system allocated another $6 million across three existing co-investments.

The report did not specify whether the retirement system is favoring or avoiding deals in certain markets or sectors. SWIB began to seek out exposure to European assets through its co-investment program in early 2016.

Wisconsin staff declined comment on the retirement system’s co-investment strategy.

LPs increasingly view co-investment programs as a way to better manage parts of their PE portfolios while reducing fees.

As surging equity markets pushed deal prices higher in recent years, co-investment capital also gave some firms access to larger, costlier deals. Almost 80 percent of the 110 firms recently surveyed by consulting firm EY offer their LPs opportunities to invest alongside their funds in certain deals.

Historically low interest rates contributed to the higher-priced environment as well, enabling buyers to borrow large amounts at low cost.

While debt ratios are typically lower on newer leveraged buyouts, Wisconsin reported seeing leverage multiples at around 6x as recently as the third quarter, according to meeting materials. Average debt-to-EBITDA multiples in the U.S. hit their 10-year peak of 6.1x in 2007, according to Bain & Co’s 2017 annual private equity report.

Leverage levels may fall as firms seek new deals after the passage of tax reform, according to the presentation.

New tax rules signed into law by President Donald Trump last year partly limited the deductibility of interest payments on company debt, capping the annual deduction at 30 percent of the company’s adjusted taxable income.

Private equity firms will likely deploy less leverage in their deals to account for the changes. Wisconsin investment staff attributed its commentary to conversations with “a number of our U.S. general partners,” spokesman Chris Preisler said.

Wisconsin’s co-investment program had invested $308 million in 22 companies as of Dec. 31. The portfolio has returned $58 million of realized returns, with another $359 million unrealized.

Action Item: To read Wisconsin’s meeting materials, visit http://bit.ly/2ogCRwn