Forbes.com

Private equity deal supply and range will increase

Private equity (PE) deal makers should see a healthy supply of attractive assets come up for sale this year.

By Hugh MacArthur, Graham Elton, Bill Halloran and Suvir Varma

First published on Μαΐου 11, 2011
min read


Private equity (PE) deal makers should see a healthy supply of attractive assets come up for sale this year. Strong public valuations and buyers’ willingness to pay rich premiums on acquisitions are giving owners of high-quality businesses reason to believe they can attract top value for their holdings. The supply of deals coming to market in the US should also get a boost this year due to the two-year tax cut extension that may spur some sellers to lock in profits at lower capital gains tax rates. In our previous posts, we discussed how a backlog of uninvested capital and a friendlier debt market will help fuel a private equity comeback. And as we covered in our recent report on the state of private equity, two supply-side factors also could drive deal activity in the months ahead. A thaw in public to private deals: Sales of public companies to private owners (P2P) drove the last PE boom, and will be essential for powering a healthy recovery. Yet, while P2P conversions came back into vogue during 2010’s gradual pickup in deal activity, both their number and size fell short of potential. Bain’s analysis points to far greater potential in 2011. Taking current equity and debt market conditions as a starting point and making assumptions about deal structure, holding periods and target returns, Bain investigated the universe of 1,400 US public nonfinancial companies with more than $500 million in annual revenues and an enterprise value in excess of $50 million. When we ran the numbers, we found that more than 400 companies—representing a combined market capitalization in excess of $1 trillion—appeared to have valuation and cash-flow characteristics that could support a P2P transaction. This estimate, of course, is very sensitive to changes in market valuations. Several factors suggest more of these potential deals could end up being realized in 2011. For one thing, banks and other lenders are increasingly willing to help underwrite bigger deals with debt financing. Also pointing to a rise in P2P deals is the attraction of PE funds to the large number of public companies carrying record amounts of cash on their balance sheets. Given today’s historically low interest rates, that cash is generating virtually no return. By taking on additional leverage in an LBO, a PE fund could unleash value and make the capital structure of the company they take private more efficient. A continued bull market for secondary buyouts: With PE funds holding near record amounts of dry powder and with PE owners facing uncertain prospects with IPOs and sales to strategic acquirers, 2011 could continue to see more asset sales from one PE owner to another. In addition, some strong secular reasons support the belief that these deals make sense and will likely remain a staple of the PE deal supply. One factor favoring secondary buyouts is that they can be completed more expeditiously than an IPO or a sale to a strategic buyer can. The number of PE-owned companies has increased dramatically following 30 years of deal making and they now represent a significant share of businesses that come up for sale. And limited holding periods can trigger the sale of a PE-backed company that still has the potential for significant upside gains. Such companies are highly attractive to other PE firms that can bring their unique capabilities to bear to realize that yet-untapped potential. Also, secondary buyouts are becoming prevalent because some companies are simply better suited for private ownership—and having found their way into PE hands are likely to remain in that environment. Likewise, many management teams that have worked with PE owners have enjoyed the experience and prefer it to operating under public ownership. Perhaps the most compelling reason why secondary buyouts make sense is their performance. One recent examination of primary and secondary buyouts in Europe between 1989 and 2006 found that the median IRR for the secondary buyouts was 32 percent, not far below the 36 percent the primary buyouts earned (see figure below). Accepting a somewhat lower IRR may be a small trade-off to make for a lower-risk investment. An investor in a secondary buyout benefits from groundwork done by the initial owner, who will have identified—and resolved—management weaknesses, hidden traps in the company’s balance sheet and financial-reporting problems. This post was written by Graham Elton, Bill Halloran, Hugh MacArthur and Suvir Varma, leaders of Bain & Company’s Private Equity Group.

Private equity (PE) deal makers should see a healthy supply of attractive assets come up for sale this year. Strong public valuations and buyers’ willingness to pay rich premiums on acquisitions are giving owners of high-quality businesses reason to believe they can attract top value for their holdings. The supply of deals coming to market in the US should also get a boost this year due to the two-year tax cut extension that may spur some sellers to lock in profits at lower capital gains tax rates.

In our previous posts, we discussed how a backlog of uninvested capital and a friendlier debt market will help fuel a private equity comeback. And as we covered in our recent report on the state of private equity, two supply-side factors also could drive deal activity in the months ahead.

A thaw in public to private deals: Sales of public companies to private owners (P2P) drove the last PE boom, and will be essential for powering a healthy recovery. Yet, while P2P conversions came back into vogue during 2010’s gradual pickup in deal activity, both their number and size fell short of potential. Bain’s analysis points to far greater potential in 2011.
Taking current equity and debt market conditions as a starting point and making assumptions about deal structure, holding periods and target returns, Bain investigated the universe of 1,400 US public nonfinancial companies with more than $500 million in annual revenues and an enterprise value in excess of $50 million. When we ran the numbers, we found that more than 400 companies—representing a combined market capitalization in excess of $1 trillion—appeared to have valuation and cash-flow characteristics that could support a P2P transaction. This estimate, of course, is very sensitive to changes in market valuations.
Several factors suggest more of these potential deals could end up being realized in 2011. For one thing, banks and other lenders are increasingly willing to help underwrite bigger deals with debt financing. Also pointing to a rise in P2P deals is the attraction of PE funds to the large number of public companies carrying record amounts of cash on their balance sheets. Given today’s historically low interest rates, that cash is generating virtually no return. By taking on additional leverage in an LBO, a PE fund could unleash value and make the capital structure of the company they take private more efficient.
A continued bull market for secondary buyouts: With PE funds holding near record amounts of dry powder and with PE owners facing uncertain prospects with IPOs and sales to strategic acquirers, 2011 could continue to see more asset sales from one PE owner to another. In addition, some strong secular reasons support the belief that these deals make sense and will likely remain a staple of the PE deal supply.
One factor favoring secondary buyouts is that they can be completed more expeditiously than an IPO or a sale to a strategic buyer can. The number of PE-owned companies has increased dramatically following 30 years of deal making and they now represent a significant share of businesses that come up for sale. And limited holding periods can trigger the sale of a PE-backed company that still has the potential for significant upside gains. Such companies are highly attractive to other PE firms that can bring their unique capabilities to bear to realize that yet-untapped potential.
Also, secondary buyouts are becoming prevalent because some companies are simply better suited for private ownership—and having found their way into PE hands are likely to remain in that environment. Likewise, many management teams that have worked with PE owners have enjoyed the experience and prefer it to operating under public ownership.

Perhaps the most compelling reason why secondary buyouts make sense is their performance. One recent examination of primary and secondary buyouts in Europe between 1989 and 2006 found that the median IRR for the secondary buyouts was 32 percent, not far below the 36 percent the primary buyouts earned (see figure below). Accepting a somewhat lower IRR may be a small trade-off to make for a lower-risk investment. An investor in a secondary buyout benefits from groundwork done by the initial owner, who will have identified—and resolved—management weaknesses, hidden traps in the company’s balance sheet and financial-reporting problems.

This post was written by Graham Elton, Bill Halloran, Hugh MacArthur and Suvir Varma, leaders of Bain & Company’s Private Equity Group.