Is this a high point for private equity?

Alex Barr outlines the opportunities for the sector

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This September, Chinese e-commerce giant Alibaba executed a well-timed IPO in the US, crystallising an extraordinary return for founder Jack Ma. Less well documented have been the gains that should eventually accrue to Ma’s private equity investors, which included New York based Silverlake Partners, a holding within Aberdeen Private Equity Fund Limited. The returns Silverlake will eventually deliver to its investors should be more than the  ‘twice original cost multiple’ yardstick that usually determines if a deal is a good outcome for private equity investors, and will have a modest impact on the carrying value of the investment for the fund. However, with equity markets currently volatile, it begs the question: does this mark a high point for private equity?

The IPO market over the last year has proven to be an effective conduit for private equity backed exits, and it is fair to conclude that this window won’t stay open forever. However, IPOs have historically only accounted for a small portion of this industry’s exits. Perhaps more relevant in determining whether private equity is at a high point is a review of other the factors that drive the global M&A market. Amongst other ‘heat tests’, this might include analysis of multiples of debt applied to deals, purchase price multiples, debt cover ratios, and equity contribution levels, as well as secondary market valuations. Whilst a number of these metrics are close to 2007 levels, some regional markets and certain sectors continue to provide relatively attractive opportunities. For example, we see plentiful opportunities for the US mid-market buyout sector.

What is often forgotten is the positive impact of operational improvement on businesses from their private equity owners. Significant incremental value can be added, for example, in streamlining existing operations, accelerating product development, expanding into new geographies and implementing more efficient manufacturing processes.  This can create additional value beyond simply buying and holding a business. As a result we tend to focus on managers that really can bring something to the table in terms of the assistance they can give incumbent management teams.

One of the advantages of a listed fund like Aberdeen Private Equity Fund Limited is that, as a permanent capital vehicle, it allows us to invest gradually and through many cycles, such that the risk of being over exposed to a period of high leverage or inflated acquisition multiples is minimised. Although private equity is a long term investment, there is a risk that no matter how good the individual asset is, if it is bought at the wrong price (among other factors), future returns may be compromised. We are fastidious in our due diligence on managers and look for those who have capital deployment discipline and who are careful about the price that they will pay for acquisitions.

So why should investors consider private equity now? In addition to the strong performance of the asset class over the longer term, there is a compelling case for listed private equity funds which, for the most part, continue to trade at substantial discounts. There are many factors that have contributed to this, one being the mistrust some have placed on underlying company valuations. Our experience suggests however, that private equity managers are, on the whole, running conservative valuation policies. The Aberdeen Private Equity Fund Limited portfolio continues to see underlying exits that are, in aggregate, being achieved at good uplifts to last recorded value.  It is no surprise that observers refer to this as the ‘double discount’ phenomena.  It is also one of the drivers of current strong secondary market valuations for many private equity funds with good underlying exit prospects.

Undoubtedly, strong macro headwinds and continued uncertainty, along with volatile markets may impact exits and multiples used to value businesses, or indeed, create a buying opportunity. However, with a renewed focus on operational intervention, many privately held businesses are likely to be in better shape and therefore better positioned to weather any uncertainty. The M&A market is likely to have some longer term support from both strong corporate balance sheets and demand from private equity funds with committed cash to invest. We believe diversified private equity portfolios offer sensible long term exposure to this asset class, and in listed form, offer key liquidity benefits allowing shareholders to alter their exposure with relative ease.

Disclaimer

This content is for informational purposes only and should not be considered as an offer, or solicitation, to deal in any of the investments mentioned herein. Information provided should not to be relied on by the viewer as advice. The viewer must make his/her own assessment of the relevance, accuracy and adequacy of the information contained in this article. No warranty whatsoever is given and no liability whatsoever is accepted for any loss arising whether directly or indirectly as a result of the reader, any person or group of persons acting on any information, opinion or estimate contained in this document. Past performance is not indicative of future results. The value of investments and the income from them can go down as well as up and you may get back less that the amount invested.

The Aberdeen Private Equity Fund Limited is managed by Aberdeen SVG Private Equity Managers Limited.

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