Private equity investors are weighing a tricky mix: high asset valuations, record levels of idle cash and an equity bull run some consider overdue for a downturn. While top dealmakers gathered in Berlin this week had plenty of words of caution, they show few signs of slowing down.
“This is going to be one of the biggest years ever for M&A,” Oak Hill Advisors Chief Executive Officer Glenn August said. With corporate cash levels getting a boost from U.S. tax reform and private equity firms holding a record $1.7 trillion of dry powder, “it’s going to be huge, or to Trump, ‘YUGE,’” he said. “I’m actually upbeat in terms of what the opportunities are.”
Investors arrived at the annual SuperReturn International Conference eager to discuss how to maintain returns while, according to Bain & Co., buyout prices set a new high last year. Alternative strategies to traditional buyouts, such as credit and long-dated funds, are gaining momentum as pensions, endowments and other investors seek varying levels of risk and return.
While the long run-up in equity markets has some investors like EQT Partners’ Christian Sinding “ quite paranoid,” there’s reason to believe that today’s high asset prices are mostly justified, according to Blackstone Group LP’s Prakash Melwani.
“These valuations are more fundamentally driven than the debt-induced valuations from the three or four previous cycles,” Melwani said.
Paired with lower corporate tax rates that promote higher after-tax cash flow and the efficiency gains from technology, assets may accordingly be worth more, he said.
Investors are mindful of the latest financial crisis, prompting comparisons between today’s conditions and those before 2008. Like Melwani, KKR & Co.’s European head, Johannes Huth, sees this cycle as different.
“I don’t think we are in a sort of 2007 scenario, it just doesn’t feel the same way,” Huth said, citing practices such as the industry’s increased use of equity in deals. “For the next 12 to 18 months, we’re going to continue to have the scenario that we’re currently in.”
“We’ll be fighting with prices this year,” said Jorg Rockenhauser, the head of Permira’s Frankfurt operations.
To deploy money, dealmakers are eyeing more structured, proprietary deals. That’s fueling the rise of add-on acquisitions -- where a fund buys a company for an existing portfolio business -- deals with family-owned companies that have long-held relationships with the firms, and minority ownership structures. It’s also underscoring the importance of trying to create exclusive sourcing processes, according to TPG Capital Managing Partner Todd Sisitsky.
“I still think the world rewards hustle,” Sisitsky said Wednesday. “CEO relationships -- the best ones always start with no ask” and can take years to cultivate before a deal, he said.
Should dealmaking pick up in 2018, it could be years before the industry sees the outcome of those decisions. Whether business growth and operating improvements can overcome the expensive purchase prices is a key question for dealmakers and their investors.
“We’ve all lived through this play before,” said Sisitsky. “You have to make sure you never let your guard down with respect to keeping a very high bar.”