Private equity: Heading for the exits?

Private equity: Heading for the exits?

Private equity funds eager to sell aging portfolio holdings may soon find new opportunities to reap capital for investors.

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Private equity: Heading for the exits?

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Exit activity has sputtered over the past three years, and private equity funds are feeling the heat to sell aging portfolio holdings and return capital to their limited partners. But as we explain in Bain & Company’s Global Private Equity Report 2013, they may soon get that opportunity amid unmistakable signs that exit opportunities finally appear to be moving into higher gear. M&A is poised to accelerate, bringing critical strategic buyers of PE-owned companies back into the markets. Sponsor-to-sponsor transactions should continue strong in all major PE markets. And strengthening public equity markets have rebounded to pre-downturn valuations, a crucial precondition for the possible long-awaited sale of the mega buyouts through IPOs.

With the overhang of assets waiting to be sold reaching $2 trillion globally, a turnaround in exit prospects cannot come soon enough. The exit overhang is heavily concentrated among the big buyout vintages between 2005 and 2008, which account for three-quarters of the unrealized capital. More than two-thirds of 2005 vintage buyout funds have yet to return paid-in capital to limited partners (LPs), and that figure jumps to over 90% for funds from the 2006-2008 vintages.

The slow pace of exits by the boom-era vintage funds has tightened the screws on general partners (GPs). In private equity’s largest markets, North America and Europe, the median ratio of buyout fund distributions to LPs’ paid-in capital continued to lag in comparison to earlier vintages as the amount of time GPs were keeping LPs’ money tied up stretched longer and longer. The buildup of an exit overhang is a relatively new phenomenon for funds that focus on the emerging markets of Asia, but it is fast becoming an existential problem for many GPs that are looking to sell a slew of investments they made when the markets started to get hot in 2006 and 2007.

Although there are many stubborn problems that will not soon be solved, prospects for a break in the logjam this year look better than they have for a long time.

Strategic sales are poised to ride a renaissance in M&A activity. Corporate buyers have long been the mainstay of private equity exits, and even a modest increase in strategic acquisitions would make a material difference to PE exits. Indeed, all indicators point to an upsurge in corporate M&A activity—from rising public equity markets and low interest rates to strong corporate balance sheets and readily available debt. Corporate debt levels have declined since 2008. Meanwhile, corporate cash and cash equivalents have hit record levels, with the S&P 500 companies now holding some $800 billion on their balance sheets. Perhaps the overriding mandate for M&A to rise is the pressure corporate executives are feeling from shareholders to put cash to work to fuel their next wave of growth.

Sponsor-to-sponsor transactions will broaden and deepen. Transactions between private equity sponsors have become an increasingly important route to exit over the past three years in Europe and North America. With abundant supplies of dry powder still waiting to be put to work, there is every reason to expect that they will only gain in frequency. But look for sponsor-to-sponsor deals to increase even in India, China and other emerging economies, where the slowdown in IPOs, long the favored exit option in these fast-growing markets, makes secondary transactions a viable backstop. Sponsor-to-sponsor deals are attractive to buyers in emerging markets because they can dispense with much of the due diligence risk that plagues primary deals.

IPOs will face challenges in Europe and Asia, but are ripe for a rebound in North America. One of the most intriguing trends to watch for in 2013 will be the pace of initial public offerings. The pipeline of filings for new buyout-backed listings worldwide was thin as the year began. IPOs were moribund in Europe and look to remain troubled throughout the year. In the Asia–Pacific region, the uncharacteristically weak IPO channel heading into 2013 poses significant challenges in a region where IPOs accounted for some 70% of all exits by value between 2007 and 2011. The brightest signs of life on the IPO front are in the US, where the strong run-up in the public equity indexes in 2012 has lifted stock prices back to near their peak prior to the financial crisis. If sustained, the gains bode well for long-awaited exits from the frozen boom-era mega buyouts, potentially allowing liquidity to begin to flow to LPs and providing a major lift for the industry’s prospects overall.

It will take a more robust IPO market to put the wind back into the sails of fund-raising and propel PE back into cruising speed. Will it happen in 2013? Stay tuned.

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


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