Bain & Company recently released their 2019 Global Private Equity Report and within it I found some interesting data points. In particular, the below chart jumped out at me.
What do you anticipate to be the biggest challenges for PE dealmakers in 2018?
Source:Crystal Ball Report 2018, PitchBook Date, Inc
This is the output of a survey of private equity firms at the beginning of 2018*. According to this, the greatest challenge Private Equity (PE) firms believe they are facing is high transaction multiples (i.e. they have to pay more to buy a business), and the second largest challenge is sourcing quality assets. Third is the degree of competition.
So what does this tell us? It tells us that PE firms are having to pay a lot to buy assets, that aren’t necessarily of the highest quality, and that intense competition is making the problem worse.
Competition in private equity isn’t like competition between your local supermarkets – there’s no race to the bottom. The race to buy a business can be an auction process that instead results in a race to the top. The winner, when private equity firms are competing to buy a business, is the one who is willing to pay the highest price. To be able to pay the highest price, the PE firm needs to have access to a significant amount of capital to put to work, or to be able to refinance transactions with forever-higher leverage metrics.
And yet, what does the survey say is of least concern to private equity players? Access to financing.
While PE firms put up some of their own capital to finance an investment, it’ll only be a small portion of the overall invested capital. The rest often comes from the leveraged loan and high yield bond markets. Easy access to financing from these markets allows the PE firms to pay high multiples.
But should financing be so easy when multiples are high enough to cause the private equity firms themselves to worry?
Should it be so easy when they’re concerned over the lack of quality businesses to invest in?
Should it be so easy when high competition for those assets pushes multiples for these businesses even higher?
With all-in yields still relatively low, particularly in Europe, we’re conscious that our investors need an appropriate return on their capital. Careful due diligence in stock selection is absolutely central to our process to ensure our investors are paid for the risk they take on. When we lend money to a business, we’re keenly aware that we are investing assets that have been entrusted to us to manage prudently.
While we would never dismiss a potential investment purely because of private equity involvement, we bear in mind their own concerns about questionable asset quality and high transaction multiples as we conduct our due diligence.
* While this survey relates to expectations for 2018, with continued strong markets (the end of the year was a brief but notable exception) multiples have continued to rise. Indeed, Bain & Company’s report goes on to note that deal values in North America rose 22% in 2018.