How do private equity investors create value? A study of 2011-12 North American exits

19 Sep

Our seventh study of private equity (PE) value creation in North America finds firms are shifting their focus as the financial crisis recedes.

In the immediate aftermath of the crisis, cost-cutting and value preservation were vital. More recently, PE has taken a different path, standardizing and systemizing value creation models and using longer holding periods to transform companies and position them for exits.

Going forward, firms must find ways to increase the rate at which they realize value through exits.

2011 and 2012 exits

Our analysis of 2011 and 2012 exits suggests a rebound in activity. PE houses have taken advantage of an active IPO market, particularly at the larger end of the entry enterprise value spectrum.

IPOs accounted for 33% of the entry EV of exits in 2010; in 2011 it was 70%. In 2012, arguably a more challenging year for public markets, the percentage was 48% — still the second highest in our seven-year study period.

A final note on exits: Secondary buyouts are performing well. Contrary to popular opinion, deals sourced from other PE firms perform at least as well as other types of deals.

EY – Weighted-average hold periods

Hold times lengthen

Despite these healthy levels, hold periods continue to rise. In 2012, companies that were exited had been in the portfolio for an average of 5.1 years.

At current run rates, it will take approximately seven years to exit the current PE portfolio. That compares to an estimated 11 years for the current European PE portfolio.

In a related issue, exit preparation times are also significant. Our recent PE Global Capital Confidence Barometer found that nearly 80% of firms spent at least six months preparing for exit, and 40% spent up to two years.

Strategic and operational improvements yield outperformance

PE continues to outperform public markets. For North American exits from 2006-12, PE outperformed by a factor of 5.4. This is in line with similar results reported in our studies of the European, African and Latin America markets.

In North America, PE strategic and operational improvements drove 50% of the total cash return for the companies in our sample. It’s clear that the PE model of active ownership produces outsized returns by improving backed companies.

Focus on organic revenue growth

PE is increasingly focused on organic revenue growth as the key means of creating value in the companies it backs. In our entire sample, organic revenue growth accounted for 44% all EBITDA growth, but this percentage has risen since 2006-07.

This suggests that PE firms have shifted their emphasis from cost-cutting and efficiency gains to supporting growth in new markets, product lines and business areas. In particular, geographic expansion has been a key driver of growth during the last several years.

Increased standardization in portfolio management

To support the focus on organic revenue growth, PE is increasingly standardizing the ways in which it manages portfolios. Firms now use robust monitoring frameworks to ensure stakeholders are aligned. Scorecard measurement metrics and other performance-related measure have also become common practice.

Our study also identified three approaches PE is taking to achieve more consistent results:

1. 100-day plans

These plans are a vital tool for setting portfolio companies on a growth path. In fact, the recent Capital Confidence Barometer reported that 56% of respondents focused 100-day plans on revenue enhancement. Only 3% reported not using them at all.

2. Operating partners model

Operating partners can identify areas for improvement and support companies through a transformation, and 40% of the deals we analyzed involved operating partners in some capacity. These deals showed increases in average equity multiples compared to deals in which operating partners were not involved.

3. Getting management right

Choosing the right CEO and management team at the outset of an investment is critical to successfully implementing growth strategies. Our findings show that companies that had to change management achieved about half the EBITDA growth compared to ones that did not.

Download “A study of 2011-12 North American exits” as a printable document.

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Posted by on September 19, 2013 in Investments


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