Business Enhancement Associates Aha! Moments: How Private Equity Is Driving Value

Tuesday, August 6, 2013

How Private Equity Is Driving Value

A new study finds that financial-sponsor-backed companies are outperforming their publicly held peers.

... From 2006 to 2012, E&Y found in its recent study of North American PE deals, PE-backed firms spawned a return of more than five-fold that of investor returns on publicly held companies.

English: Diagram of private equity fund structure for Private equity, Private equity fund, Private equity firm (Photo credit: Wikipedia)

About half of that return (realized when the PE firm sold its ownership interest) came from strategic and operational improvements. For the most part, E&Y found, it was growth in EBITDA (earnings before interest, taxes, depreciation and amortization) that created this value for PE firms’ acquisitions -- in particular, growth of the organic variety.

English: Diagram of private equity co-investment structure for Equity co-investment (Photo credit: Wikipedia)

At companies that exited their PE owners in 2010-2012, for example, organic-revenue increases accounted for 45 percent of EBITDA growth, up from 39 percent pre-recession (2006-2007). (Click here for an interactive chart.)

Diagram of leveraged buyout transaction structure for Private equity, Leveraged buyout (Photo credit: Wikipedia)

E&Y says the results stem from PE firms changing the business models of the companies they own. ...

“In the 1990s and the 2000s, if PE firms bought at the right time and then held the investment, they made money based on the multiples expansion in the public markets,” says Jeffrey Bunder, global private equity leader at Ernst & Young. Now, however, PE firms are concentrating on driving earnings growth, he says.

English: Different methods to assess value on the secondary market (Photo credit: Wikipedia)

In almost all of the PE deals E&Y studied, for instance, once the PE firm acquired the company, the financial sponsors had a 100-day plan to either enhance revenue (52 percent) or generate cash (32 percent). “It’s more of an operating model: getting the right management team in place, driving business expansion into different geographies, adding products and expanding through acquisition,” Bunder says.

But it would be wrong to suggest that the old value creators for private-equity firms no longer contribute. Higher stock market returns still drove 17 percent of PE-owned companies’ overall returns, and the additional leverage PE-backed companies took on accounted for 25 percent of overall returns. In addition, cost reduction at acquired businesses still drove 26 percent of EBITDA growth for the deals PE firms existed during 2006 to 2012.

Healthy equity markets have also enabled successful exits of private-equity-backed firms through initial public offerings. And even the multiple-expansion effect has returned. “Multiples, which compressed significantly during the post-crisis years and negatively impacted performance, have rebounded in the recovery period and accounted for 30 percent of overall PE returns,” the E&Y report says.

PE firms indeed are holding companies longer — an average of 5.1 years in the study’s deal population in 2012, up from 3.4 in 2006. While the Great Recession certainly had something to do with that, “longer hold periods … also point to increased engagement by PE owners in the businesses they back,” said the E&Y report.

For the study, Bunder’s team analyzed deals that PE firms exited during 2006 to 2012. They chose acquisitions that had an initial value of $150 million or higher.