Private Equity-backed businesses outperform public companies, says Ernst & Young
The annual rate of growth in enterprise value (EV) achieved last year by the largest Private Equity-backed businesses significantly outperformed equivalent public companies in the same country, industry sector and timeframe. Average annual EV growth rates were 33% in the US and 23% in Europe, compared to public company equivalents of 11% and 15% respectively.
These are the key findings of How Do Private Equity Investors Create Value? the second annual study by Ernst & Young on the business performance and strategies of Private Equity (PE) firms across the largest deals exited throughout 2006.
The latest study by Ernst & Young specifically focuses on exits by private equity houses in the US and Western Europe. However this theme of how private equity companies are able to grow and strengthen businesses under their ownership is also a phenomenon consistent in the ever-growing South African private equity industry. A relevant example is the Ethos-led consortium R5.4 billion exit of Waco. The company was purchased for R2.4 billion and with the introduction of strategies such as new management, growing the companys footprint and certain disposals, the company developed into a formidable and highly profitable asset.
The study emphasises how the PE industry is consistently able to grow and strengthen the companies under its ownership. The average enterprise value of the businesses studied in the US grew from US$1.2 billion when acquired to US$2.2 billion at exit. In Europe, the average value grew from US$800 million to US$1.5 billion at exit.
Employment levels were the same, or higher, at exit versus entry in 80% of US deals. In Europe employment in businesses owned by PE grew by an average of 5% per annum across the UK, France and Germany, where two-thirds of the deals took place, compared to 3% for equivalent public company benchmarks.
"Private Equity ownership creates value from sustainable improvements in performance and growth," Simon Perry, Global Private Equity Leader at Ernst & Young, comments.
"Two-thirds of the earnings growth in PE-owned companies comes from business expansion, with increases in organic revenue being the most significant element. This includes the benefits of investment in sales and marketing, new product launches, acquisitions, investment into attractive industry sectors in the US, and expansion into new geographies in Europe. Cost reduction, including operational efficiencies, is also a very important element of earnings growth in both the US and Europe, accounting for 23% and 31% respectively of the total growth in earnings," Perry adds.
What are the secrets of Private Equity's success?
The study shows that Private Equity investors are highly selective and well researched when making the decision to buy a business and have the ability to drive real efficiencies through the business plan under their ownership. This finding was true across deals in the US and all main European countries.
"Three-quarters of investments resulted from proactive deal origination strategies, including company or sector tracking, building relationships with management, or introductions from established contacts," Perry says. "Across almost all deals and ownership strategies, Private Equity investors were actively involved in the business after acquisition, making rapid decisions alongside management, challenging progress and making available specialist expertise. The intensity of engagement between Private Equity investors and management was often stronger than under the previous owners."
"Taking a company private delivers benefits including the inflow of capital, transfer of know-how, synergy enhancement and operation turnaround strategies often resulting in greater profitability and operational results private equity companies understand this better than anyone," Sean McPhee, a Director in Ernst & Young's South African Transaction Advisory Services team adds. "Private equity firms typically devote significant effort to improving the businesses they buy, often using a more rigorous and focused approach than other investment styles."
The credit crunch implications for Private Equity
Recent developments in the credit markets may have cast a long shadow, but Perry remains upbeat about the prospects for the PE industry.
"Private Equity is facing a tougher environment with the recent squeeze on credit undoubtedly putting pressure on the financing of deals," says Perry. "This environment may prompt a more conservative approach with an increasing need for due diligence at acquisition. In Europe, a key challenge will be developing alternative exit routes alongside secondary sales.
"However, market participants view this as a short term dip in activity prior to returning to a more rational climate in 2008. There is widespread solid belief in the PE model and the long-term fundamentals remain strong," Perry concludes.
