North American private equity firms have pivoted from cost-cutting and value-preservation to more of a growth agenda for the companies they back. This shift has set the stage for positioning companies well at the outset of the deal to achieve successful, higher value exits while also driving higher returns, according to EY’s latest study on value creation titled “Clear direction, focused vision.” Now in its seventh year, the study examines how private equity investors create value and how private equity firms have adjusted their core model in the last cycle of owning, buying and selling.
In a volatile M&A environment, private equity firms have consistently proven to be opportunistic investors, utilizing readily available financing to acquire businesses and refinance portfolio companies. They have also been able to capitalize on high growth markets and areas for product offerings, make fundamental operational improvements to companies, back the right management teams and effect sustainable value creation.
“Behind-the-scenes work to improve portfolio companies during this wave of low growth has really strengthened private equity firm’s value-creating capabilities,” said Jeffrey Bunder, Global Private Equity Leader at EY. “As the average holding period for portfolio companies exceeds five years, private equity firms have expanded their skills to focus more on a growth agenda to ultimately create sustainable value in these businesses.”
Value Creation Strategies and Focus on Organic Revenue Growth Drive PE Outperformance
According to the EY report, private equity continues to outperform comparable public market returns with strategic and operational improvements delivering a large share of the returns over the entire study period as evidenced by the growth in earnings before interest, taxes, depreciation and amortization (EBITDA).
While leverage and stock market performance accounted for some returns, the majority was driven by strategic and operational improvements initiated by private equity owners, which accounted for 50% of the total cash return for the companies in the EY sample.
Private equity firms have pivoted the way they work with companies. Cost-cutting and efficiency gains were imperative in the immediate aftermath of the crisis, but private equity firms are increasingly focused on organic revenue growth as the key means of creating value. Private equity firms are concentrating their efforts on investing in portfolio companies to support growth in new markets, product lines and business areas and through add-on acquisitions – cost cutting is no longer an imperative.
Over the entire 2006-2012 study period, geographic expansion accounted for 26% of total organic revenue growth. In the three years since the recession, such expansion has accelerated and now accounts for over 40% of total EBITDA growth.
Unifying Best Practices Proves to be a Struggle
Private equity firms are increasing the use of operating partners and portfolio management teams, and developing a clear understanding of what buyers will want from the business in the early stage of the deal. According to the study, the increasing use of 100-day plans has driven fundamental changes to companies from day one of an investment. Also, operating partners were used in some capacity in 40% of deals analyzed.
“All of this has required a standardization of private equity value-creation techniques that enable firms to closely monitor profits at the portfolio company level,” says Tom Taylor, co-leader of Private Equity Value Creation Advisory at EY. “However, firms with multiple deal teams still struggle to unify best practices and this will remain an area of focus for firms in the future. Increased standardization will lead to a more effective leveraging of best practices.”
PE-Backed IPOs-A Bright Spot
In 2011 and 2012, exit activity was dominated by IPOs – particularly larger exits. Annual exit value was up 49% as compared with 33% in 2010. The IPO strategy lent itself well to private equity firms working to take time to create more value for the company, and make operational changes while waiting for the right conditions in the market to exit and generate maximum value for investors. While companies that exited over the past two years have been in the portfolio for longer than in pre-recession times, which could impact returns, it also points to the increased commitment by private equity owners in the companies they back.
“Private equity firms continue to reinvent themselves in a challenging economy, using the time to regroup and redirect efforts. The key factors of success are still the same – buying well, executing well, and selling well – but the processes and resources have been strengthened to ensure portfolio companies are in the best shape possible, positioned to capitalize on an improving economy and ultimately exit,” concluded Mr. Bunder.
About the study
EY’s 2012 study provides insights into the performance and methods of private equity, based on the analysis of the largest North American businesses that firms have owned and exited over the last seven years. The owners of these businesses were not owned or based in North America themselves; this is not a study of the performance of North American-based private equity investors, but is rather an analysis of the impact of private equity on North American businesses. To avoid performance bias, and to ensure a focus on the largest businesses owned by private equity firms, exits were screened to capture only those that had an enterprise values at entry of more than $150 million.
For a free PDF copy of “Clear direction, focused vision” click HERE.
© 2013 PEPD • Private Equity’s Leading News Magazine • 7-17-13