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Buyers, Private Equity

A Robust First Half for PE

All things private equity remain healthy. According to PitchBook’s report on U.S. PE in the Middle Market, 654 U.S middle market private equity transactions closed in the second quarter of 2018 with a value of $87.6 billion. The middle market has seen robust activity, accounting for 60% of U.S. PE-backed deals, compared to 58% for all of 2017.

“I can tell you one thing, our M&A bankers are incredibly busy. They are pitching a record number of deals,” says Ron Kahn, a managing director with Lincoln International. “We should see record activity in the second half of the year and end the year on a very high note.”

However, the second quarter did show a slight drop in transactions closed and deal values. There were 7% fewer deals closed in Q2 than in Q1 and value fell 3.6%. But the slightly lower numbers probably don’t mean much. 2018 has enjoyed an even better first half of the year overall than 2017, and set a record in terms of deal value and transaction count. Through the first half of 2018, private equity firms invested in 1,358 middle market deals worth a combined $178.5 billion—increases of 16% and 5%, respectively, over the first half of 2017, according to PitchBook.

“Private equity has a record amount of dry powder and they get paid to deploy it. They are picking their spots and paying more than they like, but they can’t just sit on the sidelines,” says Kahn.  

TJ Maloney, chairman and CEO with Lincolnshire Management, agrees. “The amount of available capital out there is driving up prices to very high levels, and the higher multiples deals make headlines. What’s under reported is the lower multiple deals. There are still firms that are being judicious,” says Maloney. “There are also nuances. You can pay a 10 times multiple for a company, and that can be a good price — and you can pay a five times multiple, and it be a bad price because the company can’t perform.” For example, Lincolnshire bought PADI, a professional association of diving instructors, and paid more than 10 times EBITDA for it, but was able to sell it for over 11 times EBITDA because it was a strong performing company.

The middle market is still the darling of the industry, accounting for nearly 70% of all capital invested in private equity in the first half. And not surprisingly, many companies are gobbling up add-on acquisitions in today’s lower-growth environment. According to PitchBook, large platform companies scour the middle market for add-on acquisitions because its companies are large enough to move the needle, yet small enough to be digestible and potentially fly under competitors’ radars. Add-ons have accounted for 53% of middle market deals in the first half of the year.

The exit market is a slightly different story. Exits got off to a slow first quarter, but activity picked up in the second quarter with 183 exits worth $14.8 billion. First half figures total 393 exits worth $29.2 billion, compared with 476 totaling $43.7 billion in the first half of 2017, according to PitchBook. And corporate acquisitions have accounted for 64% of the exit value in the middle market, even though corporate acquisitions made up only 47% of the number of exits.

Lots of Dry Powder

It doesn’t look like there will be any change to the private equity market anytime soon. Even if macro economic conditions change, private equity firms still have a stockpile of capital ready to deploy. The strong middle market private equity fundraising environment continued in 2018, with 72 funds raising $61 billion through the first half. The $847 million average fund size in first half of 2018 currently exceeds the high-water mark of $786 million set in 2009.

Additionally, there are still first time funds raising capital. First-time funds accounted for 11.1% of funds closed and 5.3% of the capital raised in the second quarter. Five of the eight first-time funds closed in 2018 held a final close in the second quarter.

“As firms raise larger successor funds, there has been more room for first time funds. More and more individuals and groups are making the decisions to leave their existing firms and go out and hang their own shingle. It’s a function of a healthy market with a model for fund formation that is well mapped out. There is a play book to follow now and professionals are doing it,” says R. Whit Matthews, a senior investment director in the private equity group of Aberdeen Standard Investments.

Middle market fundraising has accounted for 88% of capital raised, the second-highest proportion in the past decade. Within the middle market, the largest funds have had a banner fundraising year. As managers establish a track record of outperformance, they can raise larger funds. For example, Thoma Bravo’s Fund X raised $1.27 billion in 2011, Fund XI raised $3.66 billion in 2014, and Fund XII raised $7.6 billion in 2016, placing it above the middle market.

“People are beginning to really appreciate private equity as an asset class as they see it consistently delivering higher returns relative to other asset classes,” says Maloney.

The experts believe the private equity industry should continue to flourish for the near term and potentially beyond. “We have been in a bull market for a long stretch now, but unless something dramatic happens it will remain robust. There is talk of a recession, but it doesn’t seem likely we will see one in the next six months,” says Maloney.

Matthews agrees. “Everything is directionally up and to the right and everyone is cautiously optimistic that things will keep going. A correction is expected at some point, as it has been for some time now, but nothing is fundamentally changing and things are likely to continue on,” he says.

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