Which private market trends will stay the course?
We look at data from the past decade
That private markets’ popularity among investors burgeoned over the past decade has never been in doubt. Investors, hungry for diversification opportunities and alternative sources of returns have poured capital into the asset class. In its recent Global Private Market Fundraising Report Pitchbook estimates that private capital assets under management (AUM) grew by almost $8 trillion between 2012 and 2022, reaching a total of $12.4 trillion in 2022.
Buyout segment’s aum growth lags behind
Drilling down to sub-asset class AUM growth paints a more nuanced picture, however. According to Bain & Co’s 2023 Global Private Equity Report, growth in the the industry’s largest sub-asset class – buyout - continued, but was outpaced by that in most of the others. Buyout’s compound annual growth rate (CAGR) over the ten-year period was 11%, says the research. While at first glance this seems impressive, the comparable rates for direct lending, venture capital and growth equity were 29%, 24% and 20% respectively.
2022 in review
That said, after the strong performance in private markets in 2020 and 2021, war in Europe, tighter monetary policy and higher inflation began to exact a toll in 2022. Initially, this was more evident in uncertainty for listed equity and fixed income, but we started to see the effects in private assets in the second half of the year.
As we detailed in Private market perspectives – our annual review and outlook, higher interest rates acted as a brake on banks’ debt financing in 2022. This led to a sharp decline in the number of large and mega buyout deals completing in the second half of the year. Where there was less reliance on borrowing to finance deals, i.e. in the small to mid-sized buyout segment, performance was more resilient, with the rate of capital deployment almost matching that of 2021.
Overall, Bain & Co’s report says that buyout deal value fell to $654 billion from around $1 trillion in 2021. Meanwhile exits (down to $565 billion) and fund-raising (declining to $347 billion) followed suit. Putting the changes in context, though, the authors emphasise that they mark the end of a trend “... that has endured (with a brief Covid brake tap) since 2010, when the industry emerged from the global financial crisis and produced a 12-year run of stunning performance.”
Shift towards smaller deals
Given the tighter credit markets, Bain also noted a shift towards smaller deals that typically require less leverage. This means that the share of deals valued at up to $1 billion increased from less than 70% in 2021 to around 80% in 2022.
A higher number of smaller “add-on” acquisitions was one of the main drivers of last year’s deal flow. Add-ons occur when a private equity firm acquires a new business and adds it to an existing large or “platform” company in its portfolio. According to Bain, add-ons accounted for 72% of all North American buyout deals in 2022. For an investor, doubling up on the assets they understand best makes a lot of sense in a time of uncertainty. They are likely to prioritise smaller deals where no leverage is required and where there is a strategic imperative.
Add-ons are important for buy-and-build strategies that help reduce effective entry multiples paid during high valuation periods, such as 2020 to 2021. An entry multiple represents the amount an investor pays for a company as a function of one of its financial metrics. Bain’s data shows that the global median entry multiple for transactions over $1 billion was almost 60% higher than for those up to $50 million (12.9x vs. 8.1x) during this time.
Valuation multiples – comparing Europe and the US
Since the global financial crisis (GFC), there has been a consistent valuation gap between US and European buyouts. In 2022 this gap widened further, with significant dry powder in the US and strong competition keeping up pricing pressure for scarce deals. In its report, Bain shows that European entry multiples started to ease off, with average EBITDA (earnings before interest, taxes, depreciation, and amortisation) purchase multiples at 10.7x, versus 11.9x in the US.
What might investors expect?
This exercise might seem like crystal-ball gazing, but there are useful lessons that can be drawn from past times of stress and uncertainty. While no crisis is the same, some investments made coming out of a downturn have generated consistent outcomes over time. Examples include vintages following the tech bubble of the late 90s and the GFC, trends that we discuss in greater depth in our report on Investing in periods of uncertainty.
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