Private Equity Expectations Ambivalent Heading Into Q2 2016

The first two months of 2016 brought a paltry 236 completed middle market transactions, according to data from Thompson Reuters — the lowest deal volume in 25 years.

Divergent buyer and seller expectations, diligence channels, regulatory issues, and financing concerns are all potential deal breakers, as we reported in a recent article on the middle market’s bleak January.

Leads for new deals did increase in February, raising hopes for deal volume later in 2016, according to Mergers & Acquisitions. A recent survey also suggests that, despite these lackluster indicators, private equity expectations are relatively rosy across the board.

The PErspective Private Equity Study conducted by BDO USA, LLP, reports that “70 percent of respondents still feel optimistic about the investment environment for the year ahead, up from just over half of respondents (56 percent) in 2015.” That said, given the current market volatility, many firms are “largely planning to replicate 2015 investment levels and priorities.”

A few key findings:

• 95 percent of firms plan to close five or fewer deals in 2016, compared to 87% in 2015
• 93 percent of fund managers plan to invest less than $250 million, compared to 88 percent in 2015
• Pricing was the top-cited challenge in 2015 and 2014
• 64 percent of respondents cited buyer and seller pricing expectations as the biggest obstacle to deals, compared to 48 percent in 2015

Industry Insights 

Fund managers identified technology (68 percent) and healthcare (63 percent) as the most likely sectors for increased valuations over the course of 2016.

In the healthcare industry, “The current dynamics in the mid-market story are that the really big-bulge brackets companies are coming in, causing higher valuations,” explained Rajeev Kapoor, a partner in the health practice of management consulting firm A.T. Kearney in Axial Forum’s 2015 whitepaper on healthcare M&A. “Private equity firms are also refreshing their portfolios and acquisition targets are preparing to be bought by larger companies to gain economies of scale and be ready for a healthcare market that is incentive and performance driven.”

Meanwhile, about one-quarter of respondents thought the manufacturing industry offered the biggest opportunity for investors. Eric Meerschaert, managing director at Chicago M&A, an Axial member, agrees: “There’s significant investment interest in consolidating manufacturing distribution channels. The industry today lends itself to fewer larger and more effective players.”

Specialists Grow

Fifty-seven percent of survey respondents said that specialization in an industry or region was part of their sourcing and execution strategy, while 50 percent said that they worked with intermediaries to source deals.

Multiples talk: a 2014 study by Cambridge Associates found that specialist investors returned 2.2.x multiple on invested capital and a 23.2 percent gross internal rate of return between 2001 and 2010, overtaking generalist funds in the same sectors who returned 1.9x MOIC and 17.5% gross IRR. (Check out this article on the specialist deal funnel for more on how generalists and specialists differ in process and execution.)