Analysis: Private equity investors fret over record U.S. buyout prices

HG Holdings

16/03/2021 11:00

By Chibuike Oguh
    March 16 (Reuters) - Private equity firms are paying more
for leveraged buyouts to keep pace with soaring valuations of
acquisition targets, making some investors leery of whether the
industry can keep delivering on promises of lucrative returns.
    The booming stock market and cheap debt financing have
helped push leveraged buyout prices to a record high, driven by
sectors that have grown as people work and stay at home during
the COVID-19 pandemic, such as technology and business services.
    Private equity firms paid an average 13.2 times a company's
annual earnings before interest, tax, depreciation, and
amortization (EBITDA) for U.S. leveraged buyouts in 2020, an
all-time high, up from 12.9 times in 2019, according to
financial data provider Refinitiv.
    Some investors are growing concerned about whether buyout
firms can deliver the 15% to 20% annual returns they target when
they raise new funds.
    "We can tilt towards better valuations and opportunities,"
said David Holmgren, who oversees $3.5 billion in endowment and
pension assets at Connecticut-based hospital system Hartford
HealthCare. He said he has been shifting his portfolio away from
private equity funds that invest in pricey buyouts to those that
specialize in middle-market deals and emerging markets. 
    Many banks have grown reluctant to help finance leveraged
buyouts at inflated valuations, exacerbating investor concerns
about overpaying, investment bankers and private equity
executives said. Private equity firms must write bigger equity
checks, making it harder to juice returns through use of debt. 
    The share of U.S. leveraged buyouts where private equity
firms put down more than 50% of the deal price as equity jumped
to 41% in 2020 from 25% in 2019, according to Refinitiv. 
    "Bigger equity checks are needed for deals where prices are
high. For a business with any growth, some buyers are willing to
pay astronomical prices," said Rob Fullerton, global head of
leveraged finance at investment bank Jefferies Financial Group
Inc  JEF.N . 
    For example, buyout firms TPG Capital and TA Associates paid
the equivalent of 16.5 times the annual earnings of Planview Inc
when they acquired the U.S. work management software company in
December for $1.6 billion from Thoma Bravo, another private
equity firm. Thoma Bravo had paid 6.7 times the annual earnings
of Planview when it first acquired it from Insight Venture
Partners for $800 million in 2017, according to financial data
providers Refinitiv and Pitchbook.
    TPG declined to comment, while TA Associates did not respond
to a request for comment.
    While some private equity firms are willing to place risky
bets on fast-growing technology companies that have yet to turn
a profit, banks are more reluctant, said Gero Wittemann, partner
and co-head of U.S. at Hg, a London-based private equity firm
with $30 billion in assets under management.
    "These companies inherently are more difficult to leverage,"
Wittemann said.
    
    FUNDRAISING SLOWS DOWN
    Buyout firms typically hold onto acquired companies for
three to seven years, so it will be awhile before their
investment returns reflect the current record deal prices. 
    There is evidence some investors are apprehensive. U.S.
private equity fundraising dropped to $203.2 billion in 2020
from its record high of $320.5 billion in 2019, according to
Pitchbook.
    Investors still have faith that private equity firms can
deliver strong returns by making companies better, rather than
snapping them up on the cheap, said Brian Gildea, head of
investments at Hamilton Lane, a major investor in private equity
funds. 
   "Valuation matters, but it's one of many things that matter
in generating returns. Our data shows returns in our asset class
don't come from buying assets cheap," Gildea said.
    Private equity firms are becoming more selective. The total
volume of U.S. leveraged buyouts dropped to $84.7 billion in
2020 from $124.3 billion in 2019, according to Refinitiv.
    Some buyout firms that do agree to sky-high prices insist
that they manage to clinch concessions that protect their
downside. These include earnouts that allow them to pay the
purchase price in installments contingent on the company's
future financial performance, as well as priority in recouping
their investment among shareholders.
    "General partners have negotiated to ensure that valuations
are in line with return expectations and to regulate downside
risk," said Erik Wong, co-investment partner at Pantheon
Ventures, which invests in private equity funds.

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 (Reporting by Chibuike Oguh in New York; Additional reporting
by Joshua Franklin in Boston
Editing by Greg Roumeliotis and David Gregorio)
 ((Chibuike.Oguh@thomsonreuters.com; +332-219-1834; Reuters
Messaging: chibuike.oguh.thomsonreuters.com@reuters.net))