PE Cash Drives Multiples

As private equity firms circle growing companies, competition is heated and multiples are increasing, says Geoffrey Haydon, Moss Adams Capital vice president

Although deal volume has been slow, growing companies are still able to generate high multiples when they are sold, says Geoffrey Haydon, vice president of investment bank Moss Adams Capital.

The trend, which started in the past year, is partially due to the expiring capital of private equity firms. According to Haydon, PE firms have about $100 billion in capital that needs to be spent, which is stirring up competition for high-growth companies.

Private equity isn't the only reason multiples for those growing companies are going up. Strategic buyers also have large stores of cash, allowing them to pay higher prices for a target then they may have been able to before, Haydon says.

Are multiples increasing for deals?

The short answer is no; the data doesn't support the idea that overall multiples are increasing. If you look at valuation multiples for announced deals in the middle market, deals under $1 billion, those valuations are about flat from last year. What we have seen, is that the companies with strong revenue growth and revenue profitability are seeing higher valuations than the past. In part, it's because the private equity community is getting more aggressive in bidding for those companies.

Is the trend sector-specific or company-specific?

What we've seen is that it tends to be company-specific rather than sector-specific.

When did multiples for those types of companies start increasing?

We've seen some multiples increasing since the beginning of 2012 through the current time, in particular with the private equity community getting more and more aggressive. In the last 12 months it has been more pronounced. There are three reasons this is happening. First, the private equity guys have $100 billion of expiring capital, and they need to spend that capital or they are going to lose it. They are all looking for the same type of growth and profitable companies, which is driving up the valuations. Second, the lending environment is still very good. The interest rates are still good, so PE firms can pay more. In 2013, given how many deals happened in 2012, there has been a dearth of strong companies in the market , so that's also driving prices up.

What are some recent deals with examples of remarkable multiples and what made those deals possible?

One of the deals that stands out is the J Brand Holdings LLC acquisition by Fast Retailing Co. Ltd., which was announced at the end of last year. The valuation multiple was 2.9 times revenue, and that's really high for a retail company. They paid $290 million for an 80 percent stake in the company. J Brand is a good example of a company that had really taken market share from its rivals in the last two or three years.

How long could we see this trend last?

Over the next 18 months we'll see this really play out. The amount of overall unspent private equity capital has been going down for the last four or five years, so that will continue to be the case. I think this near-term 18 months is when you'll see the multiples being affected by all this expiring capital.

We have a hypothesis here that right now is a really unique time in the market, and a time that's going to create a lot more deal activity and higher prices over the next 18 months. Half of the equation is the demand from private equity groups, the other half is the strategic side of things.

Even with the most recent downturn, valuations are still at near record highs. Those public companies can use their highly valued stock as acquisition currency, which should allow them to pay more than they have in the past. Secondly, they're also sitting on record amounts of cash right now. This cash is earning little yield because of low interest rates, and with the high stock value they aren't doing share repurchases. As the economy improves there is less need for that cash to sit on the balance sheet.

While we haven't seen strategic valuation multiples getting higher just yet, and we haven't seen PE valuation multiples getting higher just yet, overall we think that they will over the next 18 months.

It's rare to have a very high stock market, and have the PE sitting where they're at right now with a record amount of expiring capital; it's like a perfect storm if you're a company that wants to do a transaction from the sell side.

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