After weathering a long financial storm, private equity firms are growing bolder and have an increased appetite for investment. That is the conclusion drawn from a recent survey and study on private equity activity jointly commissioned by Duff & Phelps and Shearman & Sterling LLP in association with Mergermarket. Survey respondents, they say, are optimistic about private equity activity over the next 12 months.
A large majority of the survey respondents (87%) believe there will be a near-term increase in buyout activity, and 72% expect fundraising prospects to improve in the next year.
"Last year's significant level of fundraising, coupled with market strength and an abundance of investment opportunities, suggest that private equity activity is primed to expand over the next year," said one respondent.
The survey includes interviews with 75 private equity executives from North America, Europe, and the Asia-Pacific region regarding their investment strategies over the next 12 to 24 months. The data was compiled by Mergermarket and is dated June 9, 2014.
Here are a few highlights from the report:
- The value of year-to-date exits is US$227 billion, which is fast approaching 2013's total of US$282 billion with half a year still remaining.
- New market entrants are intensifying already fierce competition and co-investments alongside fund managers are becoming more common.
- Depth and methodology of due diligence, including attention paid to new regulatory requirements, are increasing the average time to complete a transaction; more than a quarter of respondents (28%) think that regulatory and compliance risks are the top challenges faced by private equity firms.
- On average, cross-border transactions will make up 30% of respondents' acquisitions over the next year. Across all regions, near-term exits are predominantly domestic, while acquisitions and financing reflect greater international interest.
- Nearly 40% of the respondents plan to fundraise in the first half of 2015, and a majority plan to keep the new funds the same size as their current ones.
"Across geographies and industry sectors, private equity professionals express optimism," said Bob Bartell, global head of corporate finance for Duff & Phelps. "Competition is growing, but the industry is confident that strong investment pipelines, financing accessibility, and exit options will all contribute to a vibrant industry in the year ahead and beyond."
In a 2013 report on the role of private equity in the US energy revolution, PwC examined private equity deal activity over a 10-year period from 2002 to 2012.
"During the last decade, the upward trajectory of private equity investment in the oil and gas industry has been unprecedented," said the report. "Between 2002 and 2012, the annual number of private equity investments has more than doubled. Although activity dropped during the financial crisis in 2008, the number and value of deals has been rising dramatically, driven by the recovery in credit availability, a divergence in the ratio of crude oil to natural gas prices, and a renaissance in shale resource plays that has produced the highest US oil production in 20 years."
PwC continued: "The current trends stand in stark contrast to the earlier part of the decade where activity was driven primarily by rising oil and natural gas commodity prices and a leverage bubble that burst in 2008."
The PwC study focused on the annual number of deals, which they believe provides a clearer picture of growth than do deal values, since these can be skewed by outliers such as a $30 billion transaction in 2006 and $7 billion deals in 2011 and 2012.
A number of other factors have been drawing private equity into the oil and gas industry over the last decade. The industry requires a tremendous amount of capital, and this need only continues to grow. The shale revolution is projected to require more than $5 trillion in investment over the next 20 years in the US alone—largely directed to the upstream and midstream sectors. Private equity has been moving in to capitalize on this demand for capital. This has also resulted in specific energy targeted funds often with different return profiles than the typical leveraged buyout style returns.
However, perhaps most importantly, oil and gas investment opportunities fall along the entire risk continuum and cater to practically all profiles, strategies, and appetites—everything from low-risk interstate transportation deals with fully contracted profile, to high-risk high-reward commodity price plays.
The global private equity study from Mergermarket observed that private equity firms have traditionally focused on buyouts, but that in recent years, more and more firms have been finding increased investment opportunities in growth equity, which typically involves buying minority stakes in portfolio companies that often do not have any previous institutional investment. These investments are characterized by very little leverage, if any, and are often made in companies that have tremendous growth prospects and the potential to provide outsized returns.
One Europe-based private equity partner noted, "We look for opportunities and apply our capital and experience to help increase the growth potential of businesses, thereby generating superior returns for us and our investors."
The report concludes that the private equity landscape is evolving with new competition from non-traditional sources for quality assets and increased regulatory and compliance requirements. These challenges have influenced the way the firms do business, including the valuation processes, said a US-based partner.
With healthy fundraising prospects and near-record amounts of capital, we expect private equity firms to be very acquisitive in the next year as they maneuver their way through a changing investment climate.