Cracks in the PE Bubble Beginning to Show?

In a previous thread, there was a lot of speculation around PE being the next high finance sector to follow the growing trend of squeezed margins and lower frequency of transactions.

An FT article from February 2017 mentioned how analysis from Bain showed that buyout groups' share of deals has fallen to its lowest point since 2009 (can't post links since I'm a new user).

"The research found that just 4.2 per cent of deals ended up with private equity buyers in 2016, down from 5.4 per cent in 2014. PE's share of deals peaked in 2006 at 7.9 per cent.
Recent examples of private equity groups being outbid by corporations include the purchase of Yahoo by Verizon after several buyout groups bid for the California internet search company.
Likewise, the share of total mergers and acquisition activity by value involving buyout group purchasers has fallen from 9.1 per cent in 2014 to 8 per cent in 2016, Bain found in research released ahead of SuperReturn in Berlin, private equity's main annual gathering.
Buyout groups are continuing to be priced out in 2017. Consumer groups Weetabix and Continental Foods are each up for sale, and people briefed on both processes say they are largely being fought over by corporate buyers."

What are your thoughts on this? The beginning of a long-term trend or just a temporary drought?

Comments (52)

Feb 27, 2017 - 5:24pm

Well, your article also mentions that recent PE funds are significantly oversubscribed. I would imagine that fundraising success (or failure) is a better metric for the health of the PE world, as it is a direct reflection of how institutional LPs (who are putting their money where their mouth is) view PE from an investment allocation perspective.

Feb 28, 2017 - 5:47am

Good point. If PE firms are oversubscribed by LP's, would you say that this implies a healthier PE environment as opposed to the negative points described in the article?

There has been a lot of discussion around private capital advisory and capital distribution from banks recently. I guess this could mean a lot more liquid for alternative investment managers to utilise?

Feb 28, 2017 - 5:00pm

I don't think the article is actually that negative. All it says is that big corporate buyers are winning out on some blockbuster deals and that corporate buyers are becoming a relatively larger part of the buyer universe. None of that is actually negative for PE per se, because that metric is not really a good barometer for the health of the PE world.

" If PE firms are oversubscribed by LP's, would you say that this implies a healthier PE environment as opposed to the negative points described in the article?"

Close not but not exactly IMO - I would argue it suggests that LPs perceive the PE environment to be healthier, at least relative to other options. Whether LPs are correct or not, I don't know, but they're the ones putting real dollars to work.

Feb 27, 2017 - 6:53pm

The lower percentage of PE deals is simply due to high valuations in the market, which favors corporate buyers that can pay a premium for strategic value or synergies. I don't think anyone expects that this environment to persist - we should be due for a recession in the next couple years. More dry powder might end up being a good thing as more PE capital can be deployed during a recession when there are lower valuations. A lot of 2008-2010 vintage funds had fantastic returns for that reason.

Feb 27, 2017 - 7:26pm

How would a recession prevent cash-rich corporate buyers from beating out PE firms? Even in a low valuation environment, wouldn't corporate buyers still be able to pay a premium for strategic value/synergies?

Best Response
Feb 27, 2017 - 8:52pm

It's a good question, but if corporate buyers could always beat out PE firms on price regardless of the environment, then PE as a business model would be significantly less successful. In reality, a recession would generally mean (though there may be some exceptions):

  1. The stock prices of corporates would be lower, so they would be less able to raise as much new financing to directly or indirectly pay for acquisitions
  2. Corporates would have less excess cash because profits would be lower. And if their capital structures are optimized to higher profit levels, then they would need to spend a relatively higher percent of their cash flow on interest for outstanding debt
  3. Corporations may be more risk averse to spending money on acquisitions in an uncertain environment, and may rather focus internally to improve/maintain operations whereas a PE firm would be more able to take advantage and find good opportunities
  4. A PE firm's opportunity set of potential deals increases just by virtue of lower purchase prices, making it easier to hit a minimum IRR requirement (assuming the company you invest in can perform reasonably well during/after the recession)
Feb 28, 2017 - 9:19pm

I personally agree with you conclusion (that PE is at the top of a bubble, even if just a local one), but the reasons you, and this article, offer in support are totally wrong. I'll explain my reasoning on both points (not just because I'm a dick, but also the info might be valuable to you/others).

Why the reasons you offered don't support your conclusion:
1) All else equal, a strategic buyer should always win in an auction, due to the strategic benefits/synergies (think other posters have already said this).
2) Beyond that, as someone who invests as an LP, it is NEVER a good thing if your manager is winning every auction (if they really have proprietary deal flow, it's a little different, but that's not what's was said by you/the article). If we were willing to pay whatever the 2nd highest bidder did + 5% on every PE deals in a the market / a sector, I could do it myself and have the added benefit of telling the girls at NYC bars that I work in private equity.

The reasons I agree with you conclusion:
1) Private deals have become insanely expensive relative to historical ratios.
2) Lots of allocators want PE for non-economic (in the long term anyway) reasons, such as their ability to smooth returns, which has provided PE guys a lot of dry powder (which will almost certainly lead to lower returns).
3) Unlike hedge funds, where you can pivot pretty easily in a changing market, PE firms (even the great ones) essentially just deliver levered equity returns (albeit in a very pretty, well marketed package). Said another way, if, like me, you think the risks of a general downturn in equity markets have increased over the last 18 months, this is one of the worst places you could put your money.

Life's is a tale told by an idiot, full of sound and fury, signifying nothing.
  • 6
Apr 17, 2017 - 4:11pm

Is PE dead? (Originally Posted: 04/16/2011)

Light me up if you must, but try to bring something concrete to the table:

Less Leverage

This country is going to shit

Less Capital

Deal flow seems to be dwindling at most levels (mid market, etc)

Less opportunity in general due to the economic situation

Is PE in the maturing phase of its life? Is it dying? I'm curious to hear others opinions seeing I am not as versed in the finance realm, but am being exposed to PE (working within a small PE shop)..

Feb 28, 2017 - 11:12pm

agreed. Just to add one point to those who point to the increased fundraising/allocation as a signal of LP's confidence in the sector's health - institutional investors are behind every asset bubble.

One other thing - if you assume an increasing rates environment then the increased cost to service debt combined with lower profits would offset the impact from reduced valuations.

Mar 6, 2017 - 11:37am

Who the fuck would want to buy Yahoo? That garbage can fire can't even manage to do a useable job with search let alone any of the other bullshit they do.

Follow the shit your fellow monkeys say @shitWSOsays Life is hard, it's even harder when you're stupid - John Wayne
Apr 17, 2017 - 4:34pm

Are we going to hit a PE bubble? (Originally Posted: 05/02/2007)

ok, so PE is trying to take out some firms in my sector and have failed - they're going on about leverage, sale/leasebacks and all that jazz, but the leverage hurts the operating aspect of the company. CAn this model of taking companies in, doing some fennagling and then re-listing actually work?

Apr 17, 2017 - 4:46pm

Decline in Private Equity Transactions (Originally Posted: 08/22/2011)

Industry newb here...

I have read a few articles recently about how the volume of private equity transactions is expected to decline during this period of market volatility as firms are waiting for more market clarity before making major transactions.

Given the drastic price depreciation of companies in virtually every industry/sector (gold excluded), wouldn't this be a good time for PE firms to acquire some of the companies that have been hit the hardest?

For example, there are currently a number of companies trading at P-BV ratios less than 1 - ranging from small firms to US banks. Wouldn't PE companies normally be jumping on these sorts of companies? Of course, if they expect the markets to crash further and for these companies to become even cheaper, it makes sense. But how much longer will they wait?

Aside from the market volatility, what is holding PE firms back? Any predictions for acquisitions in the short/long term?

Apr 17, 2017 - 4:48pm

Agreed. Cost of capital is the biggest impediment at this point.

I am permanently behind on PMs, it's not personal.

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