It is a seller’s market . . . to private equity (“PE”) shops at least. In the spirit of a private equity pioneer, they are selling everything not nailed down. And who are they selling to? Mainly, they are selling to corporate acquirers.
If you click on the first graph from Pitchbook, which is a data provider of PE transactions, then you will see that (emphasis added): “[In the first 9 months of 2015], total exit value via corporate acquisitions exceeded $175 billion, more than any previous year in its entirety.”
Why are corporate acquirers chasing deals with PE shops? One explanation may be they are desperate for growth. According to Pitchbook (emphasis added): “Organic growth remains hard to come by, so external growth can be the quickest way to boost their bottom lines.” This is consistent with the fact that companies have already entered a revenue recession and appear to be on the cusp of an earnings recession, and at a time when their cost of capital is beginning to rise. This comes at a price though.
The price appears to be an expensive one. Though it has not deterred corporate acquirers, price has kept more and more PE shops on the sidelines. According to Pitchbook (emphasis added): “PE investors simply do not seem to have much of an appetite for the buy side these days, quite understandably. High valuations have been a talking point for some time now, many [PE] buyers reporting that deal prices are often too rich for their taste.” Furthermore: “. . . PE shops are increasingly wary of paying multiples that will affect their ability to control future exits.” As a result, they are completing buyouts at noticeably lower valuation multiples.
If you click on the second graph from Pitchbook, then you will see that the median PE buyout price as a multiple of earnings before interest, taxes, depreciation and amortization (“EBITDA”) increased for six (6) consecutive years until 2014. After peaking at 10.7x in 2014, PE buyout valuations have since fallen by more than 20% to 8.3x in the first 9 months of 2015 (F9M-2015”).
The degree of financial leverage PE shops are using to finance their buyouts has also decreased. After peaking at a lofty 6.7x in 2013, which was its highest level in 8+ years, debt-to-EBITDA has since decreased by approximately 25% to 5.0x in the F9M-2015, as illustrated in the second graph. According to Pitchbook, this is due to concerns around debt levels, “. . . especially if rates rise in the future and refinancings become more difficult.” In other words, PE shops are prudently thinking ahead regarding their use of debt.
To summarize, PE shops are focusing on the long-term by completing buyouts at much lower valuations and using noticeably less financial leverage. Corporate acquirers on the other hand have in the F9M-2015 acquired from PE shops more than in any previous year in its entirety to chase short-term growth irrespective of high valuations and despite the risks of rising interest rates.
Investors in corporate acquirers, which largely include publicly-traded companies, should concern themselves as short-term thinking in building platform companies (e.g. Valeant Pharmaceuticals) appears to be running the show right now. It gets worse if you combine that with the possibility that the current credit cycle may be ending, which would mark the end of another merger wave. As you may know, each of the past six merger waves ended in a precipitous decline in equity prices. Please consult an investment fiduciary before making any investment decisions.