KUHN CAPITAL Tuesday, March 20, 2018
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M&A in 2016


Were it not for the fitful and mostly downward gyrations of US stock markets this January, one would be optimistic that the pace of private equity M&A deals will continue through 2016.

It’s been a very good ride so far. Factoids on the PE industry vary by source of course, but we think the following are pretty close to correct:

  • The number of American PE firms, now about 2.000, grew at nearly 5% per year from 2000 through 2014.

  • They now own about 30% of all US companies with enterprise values under $100 million

  • This percentage has been rising: in the last few years PE groups accounted for half of all US M&A transactions.

  • According to Preqin, as of June 2014 the amount of “unrealized value” (the value of unsold investments) held by PE groups worldwide had reached $2.6 trillion

  • Today in the US over 11,000 PE-backed companies employ 7.5 million people.

  • In 2015, 60% of the capital raised by PE groups across the globe was raised by those headquartered in America. And last year they also accounted for 63% of the world’s buyouts.

  • The amount of “dry powder” or overhang (funds raised by PE firms from limited partners but not yet invested) is as high today as it’s been since 2009. In 2015 the global total was $461 billion, up 3% from 2014. That fact is a powerful motivator for PE firms to keep on investing (e.g., buying).

  • Yet even in the face of this unused capacity, PwC says that 90% of PE buyout groups plan to raise additional funds in 2016.

  • PE firms have for the last six years consistently delivered a median net IRR of 14% while Cambridge Associates says that over the last 10 years the S&P 500 generated 8%.

  • Also according to Preqin, today 92% of limited partner investors in PE firms feel that their PE investment during the period 2012 – 2014 met or exceeded return expectations.

  • But those limited partners haven’t ignored the success enjoyed by their PE masters. Eager to avoid PE fees, increasing numbers of family offices are going direct, getting into the buyout business for themselves.

  • America is the world’s most target-rich environment. The revenue generated by US companies with sales exceeding $250 million is about $18 trillion versus China in second place at $10 trillion. And given China’s political and current economic environment, it takes a lot more chutzpah to invest there.

  • According to the New York ACG in its survey of 142 dealmakers, 66% of them thought that the number of PE deals closed in 2016 will be greater than 2015’s count. (Of course that survey was completed before January’s stock market declines.)

So what’s not to like? Well, despite all the vitality of the PE industry, it’s vulnerable to public market pessimism. We face a dreary catalog of ills: if the world economy continues to slow or deteriorate, if China continues to crudely manipulate its currency and trading markets and fails to contain the massive debts of its state-run companies, and if oil/gas prices stabilize at levels where they’ll trigger widespread energy industry bankruptcies, these things will eventually depress the “animal spirits” of the M&A markets.

We’ve seen it before. After the housing bust the EBITDA multiples paid for targets declined, sellers became reluctant to divest at what they believed (correctly) were low prices, strategic buyers immediately raised their skirts and scampered away, and PE buyers eventually followed suit, declining to buy targets that looked like they were or could become “falling knives.”

Every cycle is different in some ways, yet the same in others. We doubt 2016 will become as severe a squeeze on M&A as 2008, but we’re expecting a pull-back.
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