The Private Equity Bubble(s)

Dating back to the mid-nineties, private equity funds have experienced two significant bubbles driven by major economic events impacting capital fundraising: the technology bubble of 2000 followed by the “Great Recession”.  As depicted in the graphic below, private equity fundraising peaked at more than $300 billion in 2008 before sliding to less than $70 billion in 2010.  Interestingly, the annual average for the past four years was approximately $100 billion and is only slightly below the “bubble” level of FY 2000.

Source: Pitchbook, S&P Capital IQ and PCE Investment Bankers

Despite a lower level of capital raised the past few years, private equity transaction volume has recovered from a precipitous drop in 2008-09 and has remained above historical, pre-2006 levels.  This rebound in activity is partly due to the nature of private equity funds – “use it or lose it”.  This is unlike strategic buyers who can hold funds without fear of being forced to use or return excess cash.  The current $450 billion capital overhang would indicate a continued high level of transactions relative to the amount of capital being raised over the next few years.   The typical correlation to funds raised and transactions will not return until fund resources are exhausted or investment periods expire.

An interesting data point is the historically lower number of funds being formed versus the amount of funds raised.  Two observations – (1) the average private equity firms now exceed $1 billion in fund size; (2) there could be a reduction in the number of private equity firms due to the inability to raise new funds.  The number of funds will impact the number of transactions, but not in the near future.

Market Activity

As 2012 came to a close, private equity fundraising as well as the M&A market as a whole was inundated with news related to the Fiscal Cliff, creating an air of macroeconomic ambiguity.  Fortunately, M&A market participants looking to make use of advantageous capital gains rates, propelled deal count forward in the fourth quarter as companies concentrated on non-strategic divestitures and smaller, tuck-in acquisitions.  Fourth quarter transaction volume in the U.S. for strategic and private equity buyers alike, outperformed each of the preceding quarters of 2012.  In spite of a strong closing quarter, overall 2012 volume declined slightly from 2011.  On a rolling 12-month basis through 4Q12, total transaction volume was approximately 9,300 deals, while the year prior was more than 9,600.

From a value perspective, of the deals that disclosed transaction values (~ 28% of strategic buyers and ~ 30% of PE buyers), the market observed an uptick in dollar growth.  Strategic value increased from $578 billion to $660 billion on a TTM through 4Q12 over 4Q11.  Private equity funds invested $63 billion on a rolling 12-month basis through 4Q12, compared to $53 billion for the same time frame through 4Q11.  Despite the increase in total reported dollars during the year, transaction multiples fell when adjusted for several large transactions.  Median TEV / EBITDA multiples fell to 10.2x during 2012 from nearly 11.0x during 2011.  This may be an indicator that business owners were willing to accept lower values during 2012 due to increasing tax rates and fiscal uncertainty.


Moving into 2013, anecdotal evidence due to reported “lack of deal flow” indicates that M&A activity may drop in the first half of the year because of lead-time associated with closing M&A transactions.  This lead-time combined with a strong 4Q12 suggests a narrowing residual deal pipeline.  Substantial cash on corporate balance sheets, continued access to debt as well as a $450 billion private equity capital overhang will continue to drive demand for deals and help bolster M&A closings in 2013. Though it is anticipated that this will not occur until the second half of 2013; therefore overall 2013 volume will likely be down for the second straight year.

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Michael Poole

Investment Banking
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