Nearly $300 bln to Spend and Too Much Competition. That's Why European Private Equity Moves Slowly
In 2007 European private equity funds sealed deals worth $194 bln and had $197 bln in their coffers; in 2014 deals plummeted to $94 bln, while dry powder soared to $298 bln, according to Preqin data. It looks like a zero-interest, zero-inflation, cheap debt and high market valuations environment is not easy to navigate for private equity firms (from 2008 to 2014 European stock prices have risen 85% and price/earnings ratio has grown from 10.9 to 21.2).
Does Private Equity Generate Value?, a paper by Bocconi Baffi Carefin Center's Stefano Gatti and Carlo Chiarella in joint with Goldman Sachs, presented today, singles out the conflicting pressures to invest and not to overpay and the competition from corporate takeovers as the reasons of the inefficient use private equity funds are making of the raised money.
The scholars reach their conclusions analyzing all the 31,792 deals recorded by Bloomberg from 2005 to 2014, i.e. 4,088 private equity buyouts worth $648.7 bln and 27,704 corporate takeovers worth $2,900 bln and dividing them into three periods. The pre-crisis period (2005-2008) is followed by a post-crisis period (2009-2011), featuring good credit conditions, low market valuations and investors' uncertainty, and by a post-quantitative easing period (2012-2014) featuring inexpensive credit, investors' confidence and high market valuations.
Data show that , when market prices rise, private equity deals suffer while corporate takeovers thrive because companies are less interested in financial returns and more inclined to pursue industrial synergies. In the pre-crisis period, furthermore, the average value of a private equity deal was $487 mln and the average value of a corporate takeover $235.7 mln, but in 2014 the gap has been almost filled, with respective values of $319.3 mln and $311.5 mln.
The plunge in buyout numbers is almost completely due to deals in over-heated industries, whose market valuations are extremely high. In other industries a target's high price is not enough to make private equity firms give up.
Baffi Carefin Center's scholars conclude suggesting that European private equity firms need to specialize by focusing on specific industries or on smaller to middle market deals as industry expertise, target selection, deal execution and early move are going to be key success factors in such an increasingly challenging market. According to private equity professionals surveyed by Preqin, healthcare, retail and technology and media will be among the most active sectors in terms of private equity deals, while a remarkable 86% majority expects investments will be targeted to the small-to-mid-cap segment of the market.
A full comeback of buyout activity to pre-crisis levels, though, requires either a substantial improvement of future economic expectations or a correction in stock market valuations.