The Lincoln Private Market Index (LPMI), which tracks changes in the enterprise value of US privately held companies, increased by 1.5% during the first quarter of 2023.
According to Chicago-headquartered investment bank Lincoln International, growth in the LPMI was driven by operating performance rather than multiple expansion. While the LPMI increased, the rise was mild in comparison to the S&P 500, which grew 8.2% during the first quarter. Both indices grew despite headwinds, including the collapse of Silicon Valley Bank in March, which led to a modest pullback in the S&P 500. Since Q1, however, the S&P 500 has rebounded to levels seen in February before the pullback.
From the inception of the LPMI in 2014, changes in the index have conformed with changes in the S&P 500. While the changes in the LPMI have been less volatile, the two indices have converged in multiple quarters, including Q1 2023. As of Q1 2023, the LPMI and S&P 500 sat nearly on top of each other, with the LPMI growing 52% since inception and the S&P 500 growing 51% over that period.
Leverage continued to decrease on new deals as interest rates continued to rise, with leverage clocking in at its lowest level in the last two years at 4.8x.
“Fundamental performance, rather than multiple volatility, is the primary driver of value in the private markets, and private equity appears to have done a good job of navigating the current inflationary and recessionary pressures,” said Steve Kaplan, a professor at the University of Chicago Booth School of Business, who assists and advises Lincoln International on the LPMI.
Amid Growing Market Share, Direct Lending Remains in a Period of Price Discovery
While 2023 has been off to a slow start from an M&A and lending perspective, there has been a stark contrast between activity in the broadly syndicated loan (BSL) market and the direct lending market. Nearly all M&A financing in 2023 has been done through the direct lending market rather than the BSL market, including transactions that previously may have been done in the BSL market due to their size. In addition, among other factors, the collapse of Silicon Valley Bank has led to a shift away from bank-led financing towards direct lending (non-bank lending). In an uncertain environment, borrowers prefer the certainty of execution that direct lending brings, despite its higher cost of borrowing.
Based on data from Lincoln’s database, the average spread on new direct lending issuances was 6.6%, marking the second quarter in a row that the average new issuance spread was greater than 6%. This was an increase of approximately 0.50% from the prior year. Lastly, leverage continued to decrease on new deals as interest rates continued to rise, with leverage clocking in at its lowest level in the last two years at 4.8x.
“The direct lending market is at a bit of a crossroads at the moment,” said Ron Kahn, a managing director and co-head of Lincoln’s valuations and opinions group. “Interest in the asset class remains strong and credit terms have remained favorable for lenders; however, as rising rates persist, all-in yields can only remain in the mid-teens for so long. At some point something needs to break—either cracks start to form and defaults jump up or spreads start to move in the opposite direction to ease interest burden on PE portfolio companies.”
Private Company Growth Continues into Q1 but Will It Last?
Q1 2023 represented another quarter of resilient performance by PE-backed portfolio companies, despite continued inflationary pressures which spurred beliefs that private company performance could take a turn for the worse. Approximately 81% of companies tracked in Lincoln’s private market database showed LTM revenue growth for the period ending March 31, 2023, as compared to the period ending March 31, 2022. However, only 61% of companies exhibited LTM EBITDA growth over that same time. These figures compare to four-year averages of 66% and 55%, respectively. It should be no surprise that given the gap between revenue and earnings growth, EBITDA margins have contracted 2% year-over-year.
Private companies have been able to largely handle the curveballs thrown at them in 2022 and, looking ahead, it appears as though portfolio companies and sponsors are expecting that growth to continue.
For the full year of 2023, private companies are projecting an average revenue and EBITDA growth of 10%. This perhaps suggests that the margin contraction experienced in 2022 is expected to tail off, but at the same time, margins are not expected to expand in the near term. Lastly, it remains to be seen if this EBITDA growth is achievable. Since the inception of the LPMI, there has not been a year in which EBITDA growth has reached double digits.
Unsurprisingly, companies in the consumer industry have displayed the weakest performance recently, with LTM revenue growing approximately 12% from the year prior and LTM EBITDA declining 2% over that same timeframe.
“Private companies have been able to largely handle the curveballs thrown at them in 2022 and, looking ahead, it appears as though portfolio companies and sponsors are expecting that growth to continue,” added Mr. Kahn. “However, market participants remain cautious if this growth can be achieved and as a result, there has been a marked slowdown in M&A activity in the early innings of 2023.”
The LPMI was launched in 2020 and measures the variation in private companies’ enterprise values by analyzing the aggregate change in company earnings as well as the prevailing market multiples for approximately 800 private companies – primarily those owned by private equity firms – each generating less than $100 million in annual earnings. The index is calculated using anonymized data on an aggregated basis by Lincoln’s valuations and opinions group.
The methodology used by the LPMI was organized by Lincoln in collaboration with Professors Steven Kaplan and Michael Minnis of the University of Chicago.
Follow this LINK to see the full Q1 2023 Lincoln Private Market Index report.
Lincoln International provides mergers and acquisitions advisory, private funds and capital markets advisory, and valuations and fairness opinions. The firm is headquartered in Chicago and has more than 20 offices in 15 countries.
© 2023 Private Equity Professional | May 19, 2023