The world of private equity (PE) is vast yet secretive and is expecting a record year for 2019. As most PE firms are not publicly traded, these investment companies do not have to disclose much information about their holdings despite being behind some of the largest businesses in the world. Dell, Formula 1, and even our beloved Dutch HEMA are or have at one time been in the hands of PE firms –and business is booming. Triggered by abnormally low interest rate levels, PE deal making has hit its highest level since the 2008 financial crisis with a deal value of approximately $250 billion in the first half of 2019 alone. As inflation remains stubbornly low, there are no sign of slowing down in the foreseeable future with central banks reluctant to pull the brakes by raising rates –for now.
PE firms have been on a roll in recent years, taking advantage of favourable macroeconomic conditions by using increasing leverage to finance acquisitions and maximize return for their investors. This is particularly the case in the U.S., where the majority of deals are leveraged by six or more times the annual EBITDA of the target company. This has passed the pre-crisis peak experienced in 2007, indicating that this is truly a boom time for PE-led M&A activity. Armed with record amounts of investor capital and the ability to take out loans relatively freely and cheaply, PE firms race to outbid each other –further propping up prices in the process in what has become a seller’s market.
The funds of PE firms are now awash with record inflows of capital from investors. These are intended to grow their portfolios through acquiring new target companies at increasingly inflated prices. This has led to a (estimated) record $2.44 trillion of unallocated cash or ‘dry powder’ across global PE funds as managers are hard pressed to find valuable target companies at acceptable prices. Nevertheless, inflows keep coming, as many investors perceive PE funds as more attractive than conventional stocks and bonds. With the former being perceived by many as overly volatile and the latter too unattractive due to low yields, investors are promised superior returns despite an increasingly crowded market.
These investors are hardly being turned down with tens of billions of dollars being raised to establish massive new funds. This year promises to be a record one for fundraising as PE firms are on track to gather an estimated $1 trillion by the end of 2019, with most capital going to the largest 50 funds. This would be a remarkable increase from the record high of $566 billion gathered in 2017. Luxembourg-based CVC, for instance, is seeking to launch Europe’s largest PE fund through gathering more than €18 billion by the end of 2019. This capital is also being put to work this year, particularly in the U.S. and Europe where multiple deals valued at over $10 billion have been closed such as EQT Capital’s acquisition of Nestlé’s skincare unit.
Despite an inflated market, PE-backed deal making shows no signs of slowing down in the foreseeable future. This has raised concerns for how long these boom years will last before interest rates are increased. In this event, it is likely that some PE firms will find themselves struggling to finance the high levels of debt used to purchase overvalued portfolio companies amid a sharp reversal in investor confidence. As the good times continue to roll, investors should be wary not to get in over their head by keeping in mind that things may change greatly in the (not so distant) future!
Written by Jasper Thouin