From Our Briefings Newsletter

29 OCT 2018

The article below is from our BRIEFINGS newsletter of 29 October 2018:

Briefly . . . on the Growth in PE Deal-Making

Deal-making by private equity firms has surged this year, fueled by an influx of capital. We sat down with Goldman Sachs' Alison Mass, global head of the Financial and Strategic Investors Group in the Investment Banking Division, to discuss the evolving landscape for PE investors.

In your conversations with PE investors, what are some of their top concerns?

Alison Mass: PE investors want to know how they can generate strong returns in what continues to be a world of low yields – even with the recent rise in interest rates. For context, 10-year Treasurys and high-yield bonds are yielding about 3.2% and sub-5% today, respectively, compared with the yields in the mid-teens in 1981, when I started my career.

As a result, low absolute yields have pushed more investors into the alternatives space because they simply can't generate the same returns in the public markets. The search for yield has set up the strongest fundraising environment I've seen in my entire career. At the same time, PE firms must deploy record amounts of cash at a time when multiples are also extremely high. The average deal over the last year sold at a roughly 11 times multiple to a company's valuation, including debt. And we're seeing demand for assets with multiples as high as 25 times by some measures – and these are for stable businesses, not just those in the tech sector.

Can PE investors continue to deliver these types of returns? What challenges to performances are they facing in the current environment?

AM: Returns on PE deals are moving lower on average. And as a testament to a more challenged return environment, more than half of all PE acquisitions completed this year were what we call "add-on" acquisitions where PE investors buy a complementary business they already own in their portfolios instead of acquiring a company in an entirely new industry. We do, however, expect the dispersion of returns to move higher as the strength of PE firms' operating models becomes an increasingly important differentiator.

What are the other ways that PE firms are looking to grow?

AM: PE firms are looking for creative ways to grow. Selling minority stakes in their general partnership to finance growth is one example. And many private equity shops are also deploying their capital to seed a broader range of other strategies, across industries and product mixes. At the same time, PE investors are looking at succession planning within their own firms. We are starting to see more firms plan for succession while others have already successfully completed the transition process. Succession planning will continue to be an important focus over the next several years, demanding careful consideration and execution.

Technology is a force that is disrupting all areas of finance. How are PE investors leveraging technology?

AM: Technology is critically important. Firms are working to harness the breadth of data from their own portfolio companies and management teams to source better deals, make more effective investment decisions, and improve their work flow and operating models. We've seen some PE firms hire a head of innovation who sits on the investment committee to identify potentially disruptive businesses and technologies across portfolio companies. Others believe that having one person focused on technology isn't going far enough and are embedding tech specialists in every single industry vertical. Technology is no longer its own sector – it impacts every sector.

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