High Valuations Persist, Yet Private Equity’s Appetite for New Deals Holds Strong in 2018 – BDO Survey

January 2018

Taina Rosa
Bliss Integrated Communication
(646) 386-2922

Private Equity Confronts Challenging Deal Environment 

Chicago, IL – Institutional investors continue to commit vast amounts of capital to private equity funds, and as the competition for deals intensifies, deal multiples are reaching record highs and investment holding periods are getting longer.
In fact, 37 percent of private equity fund managers point to institutional interest in the private equity funds as the main driver of dry powder accumulation, followed by competition for deals (30 percent), and high valuations (24 percent) as the top issues on the minds of PE fund managers, according to BDO’s Ninth Annual Private Equity PErspective Survey.
“We have heard that institutional investors plan to continue allocating capital to private equity, even if holding periods are getting longer and returns could see somewhat of a dip,” said Lee Duran, National Private Equity Partner at BDO. “That really speaks to the strength of the asset class, especially as it enters a maturity phase.”
While fundraising for private equity continues to rise, median enterprise value-to-EBITDA multiples skyrocketed in 2017, quickly surpassing the five-year median multiple. On top of this, private equity funds’ holding periods are extending beyond the average three to five-year period. The percentage of fund managers holding on to investments for an average of four to five years inched up from 32 percent in 2016 to 33 percent in 2017; but those with hold periods averaging five to six years have grown from 22 percent to 28 percent; and those with hold periods of six to seven years have grown from 11 percent to 13 percent.
Despite the challenging deal environment, private equity fund managers are determined to put their money to work in 2018. Looking ahead, 58 percent of private equity fund managers intend to continue seeking acquisition opportunities over the next 12 months. Another 42 percent of fund managers surveyed plan to exit one or more current investments in 2018, with the majority of respondents (68 percent) anticipating that sales to strategics will provide the best returns. Only two percent of fund managers favor initial public offerings (IPOs) as an exit strategy.
“Private equity firms are up against very tough competition,” adds Scott Hendon, National Leader of BDO’s Private Equity practice. “That could tempt some firms to pay up for less-than-ideal targets, but if they can instead find those few diamonds in the rough that no one else has thought to look at, they will do very well by avoiding the high valuations and intense competition.”
Private equity firms are also willing to take on more leverage. While 44 percent of fund managers do not plan to do so, the remaining 56 percent plan to raise debt over the next 12 months to refinance portfolio companies’ existing debt, take dividend recaps and finance operational improvements.
These findings are from the BDO Private Equity PErspective Survey, a global survey of more than 200 private equity fund managers conducted by PitchBook, an independent and impartial research firm dedicated to providing premium data, news and analysis to the private equity industry.
Additional findings from the Ninth Annual Private Equity PErspective Survey include:
Political Shifts Induce Caution & Optimism: Overall, private equity firm partners surveyed expect the Trump administration to have a favorable effect on the environment for private equity, with 42 percent saying the new administration could increase investor interest in the asset class. With US tax reform officially enacted, fund managers point to changes to carried interest taxation (48 percent) and the elimination of interest rate deductibility (44 percent) as potential hurdles, while 57 percent of fund managers describe it as the national policy issue that is having the greatest impact on their firm’s investment strategy. For 27 percent of private equity fund managers, international tensions such as the rhetoric between the U.S. and North Korea and turmoil in the Middle East are causes for concern. NAFTA renegotiations, and talk of protectionist measures, also bring pause to 23 percent of respondents. 
European Challenges Mirror U.S. Hurdles: European private equity fund managers are concerned about the gap between buyer and seller price expectations, with 42 percent of international respondents deeming it the main challenge to getting deals done. Despite this, 84 percent of respondents are already directing most of their capital toward new deals. For new acquisitions, 58 percent of international respondents expect investment periods to increase. 
Tech’s Growth Endures: Fund managers surveyed say that directly managing tech companies entails challenges such as identifying growth opportunities (42 percent), and finding and retaining management teams (33 percent). Still, an overwhelming majority, or 92 percent, of tech-focused private equity firms expect the value of their portfolios to increase over the next 12 years. Among the tactics they plan to use to drive valuations upwards are to diversify products and services (96 percent), evaluate cybersecurity risks (95 percent) and implement digital transformation strategies (95 percent).
Industry 4.0 Powers Manufacturing Deals: Private equity firms recognize the opportunity to scale up their manufacturing portfolio companies’ technology. Nearly nine in 10 (87 percent) of fund managers plan to implement digital transformation initiatives for their manufacturing companies in the next 12 months. However, NAFTA renegotiations are undermining cross-border manufacturing deals. The clear majority (81 percent) plan to dedicate less than 10 percent of their fund to deals outside of the U.S. and about three-quarters (73 percent) will not pursue cross border deals in 2018.
The BDO Ninth Annual Private Equity PErspective Survey is an international survey of more than 230 senior executives at private equity firms in the U.S. and internationally. The survey is administered by PitchBook, an independent and impartial research firm dedicated to providing premium data, news and analysis to the private equity industry.
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