Andrew Cristinzio, PwC's Private Equity Leader, and Dean Bekas, a partner from PwC's Private Company Services, provide their take on the current US private equity (PE) dealmaking landscape and emerging trends. They also discuss the types of competitive edges PE firms are looking for to ramp up growth as well as their long-term outlook and other key factors impacting PE.
What is your take on the US private equity (PE) dealmaking landscape as we head into the back half of 2018?
Andrew and Dean acknowledged this is one of the best fundraising environments in history. Mega, top-tier and middle-market firms with strong track records continue to raise funds with favorable terms, due in part to large increased interest by LPs in PE. For the largest funds, there is a mounting interest in investing across borders to focus on more sizable and complex opportunities, particularly by those funds that have the capacity, global expertise and resources to do this effectively. On the other hand, best-in-class funds that don’t have the same global reach are implementing a thematic strategy and/or sector focus to try and stand out in the current competitive landscape. All these factors are helping to contribute to deal volume, attracting new entrants and non-traditional investors. Dean agreed with Andrew and added that these new entrants and non- traditional PE investors—including high-net-worth individuals, family offices, and others—are active in the lower middle market. There has been a lot of added focus on the middle market given it is a source for add-on opportunities, which allow valuation optionality due to potential cost- savings. Further, high valuations have placed added focus on the necessity to have a value creation framework during the evaluation phase that can be fully vetted during due diligence and form the basis for the underlying investment thesis. In addition to the operational levers that can be utilized to drive value, Dean suggested there has been a significant increase in the number of buyouts in the mid-cap private company space. These types of companies are attractive candidates for the inorganic growth levers within the value creation framework.
What primary drivers do you see emerging from this current environment that will shape the back half of 2018 specifically? Do you see the prior trends shifting or accelerating?
With so much capital to deploy, Andrew noted, PE firms are paying close heed to their deal sourcing strategies as they look to innovate in order to thrive in the current environment. Take the lower middle market for example; many US-based entities are looking to expand overseas, so for those PE firms targeting such companies, demonstrating operational expertise and standing leveraging relationships is critical. PE firms continue to opt for add-ons—which often can be completed for a more attractive entry price—that they can acquire quickly to drive operational improvements and expand operational footprints of their current portfolio companies. For example, suppliers typically need to demonstrate capabilities across more than one geographic location to effectively serve their customers, and thus will look for targets to maintain and grow those capabilities.
Depending on the situation, Dean stated, funds can also offer different forms of liquidity to owners of small to medium-sized enterprises. Some owners may not wish to sell right away, but rather obtain some infusion of liquidity and still remain involved with their businesses to some extent.
Are there additional methods of value creation for PE firms to adopt in the current landscape, especially given how pricey transaction multiples can be nowadays?
Coming out of the financial crisis, many PE firms were unprepared to retool or reimagine their portfolio companies, as few had experienced such a shift in the business cycle. Now, however, that has entirely changed. The firms that will be able to successfully harvest current investments in the future tend to compose a valuation creation thesis at the outset of deal sourcing that remains executable through the changes in the current environment. In the course of PwC’s PE practice now, Andrew said, we spend a significant amount of time helping our PE clients design valuation theses. There is little reliance on multiple expansion in the market now; value creation will be key.
What types of competitive edges are PE firms looking for in deal sourcing and the landscape as a whole? What types of transactions are they looking to engage in more frequently, given the current environment?
Andrew contended that PE firms will increasingly look to invest in corporate carveouts. The environment is favorable for divestitures, especially given the AT&T-Time Warner ruling, which could be seminal for mega-deals and, in turn, accelerate the carveout trend. Proactive corporate governance will lead managers to analyze their portfolios streamline operations, potentially resulting in preemptive shedding of assets. On the other hand, if anti-trust concerns emerge, there will be involuntary shedding of assets during mega-mergers.
Andrew also observed an uptick in traditional buyout shops entering the minority stake, growth investing space. Some financial sponsors are increasingly looking for portfolio exposure in areas of fast growth, while some owners of software and technology companies are looking to take on a value-add financial partner and obtain capital to ramp up growth even further.
Are there other factors you see impacting PE or affecting even longer- term outlooks?
Data privacy and protection will continue to be a primary concern for PE sponsors and their portfolio companies, Andrew noted. Such concerns are an accelerating global corporate phenomenon. On the macroeconomic side, more generally, activity looks set to be robust over the next 18 to 24 months. However, as there is a greater chance of a recession in the next 36 months, the investment cycle could eventually slacken in tandem with any economic slowdown, albeit on a lagging basis. That said, PE investors could also benefit from a deflation in valuations across financial markets. Management teams analyze their models in order to see how they may need to adapt. In addition, businesses are analyzing their overall supply chains and relationships with their customers in light of those changes.
We would be amiss if we did not mention tax reform as another factor that will impact PE. Tax reform will no doubt have a substantial impact on PE funds and their portfolio companies. Market participants will have to continually evaluate the tradeoff between the benefit of a reduced corporate and individual rate and increased limitations on the ability to claim certain deductions like interest.
Private Equity Leader, PwC US
Dean C. Bekas
Partner, Private Company Services, PwC US
Private Equity Leader, PwC US
Private Equity Assurance Leader, PwC US
Private Equity Tax Leader, PwC US
Private Equity Advisory Leader, PwC US