Private equity: celebrating record transactions looks premature

At a time of record-breaking private equity activity, Henry Kravis’s wisdom bears remembering. The KKR founder said a buyout only merited applause when it proved fruitful, not when it was merely announced. Since the start of 2021, there have been nearly 6,300 private equity transactions. The figure is a record. It has helped to propel the nominal value of merger and acquisition transactions in the second quarter to $1.5tn. That makes four consecutive quarters above $1tn. 

Private equity firms continue to raise enormous sums of capital, not just for corporate buyouts. This money can go to sundry strategies developed for yield-thirsty pensions and wealth funds. Whether Masters of the Universe like Kravis merit their high fees when listed securities are rising remains a question.

As valuations climb, private equity firms are not even pretending to seek out value. With junk bonds yielding just 5 per cent or less, and a healthy economic outlook, private equity investors bet that growth alone justifies high multiples paid. The median enterprise value to ebitda multiple for US buyouts hit 14.7 times in the last quarter of 2020, according to PitchBook.

For all the alleged operational expertise private equity firms bring to deals, purchase price determines returns more than any other variable. That means limited partners are in for a rude surprise in five to seven years time.

A more interesting question: why has private equity dry powder climbed to a record $1.5tn, according to Preqin calculations, when public market returns are so good? Private equity firms record both lofty realised and unrealised gains simply because all market values persistently arc upwards.

Another performance measure, public market equivalent, tries to correct for the rising tide. PME data collected by PitchBook reveals that the ratio of aggregate private equity returns to public markets ranged between 1.3 to 1.6 times two decades ago. The wise will have noted that this multiple has slipped to between 0.9 and 1.1 in recent years. Hardly worth the heady fees required.

Lex recommends the FT’s Due Diligence newsletter, a curated briefing on the world of mergers and acquisitions. Click here to sign up


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