Released in the wake of PE's strongest year since the global financial crisis, Bain's latest Global Private Equity Report takes a comprehensive look at the sources of continuity and change as PE investors work to build on the industry's recent success. Key fundamentals remain strong: Robust public equity and debt markets are helping to boost asset sales, enabling PE firms to return capital to their limited partners and facilitating new rounds of fund-raising. But high asset valuations and volatile capital markets handicap PE deal making, and competition for deals remains ferocious. Also, slowing economic growth has taken some of the luster off the once-hot emerging markets.
Looking only at the deal-making statistics for 2013, one might easily conclude that the PE industry is still in the doldrums, with deal value and count little changed from prior years. And while it is true that pricing and competitive conditions make it challenging to get good deals done, other forces are strengthening the PE industry and will help propel winners forward over the coming year.
Exits are increasing, and ubiquitous dividend recapitalizations and a flurry of post-IPO follow-on sales are putting huge amounts of capital back into LP coffers. In fact, many LPs have had net positive cash flow from their PE investments for the past two to three years. This happy result also creates a problem: LPs’ PE portfolios are now shrinking in many cases, resulting in a decreasing allocation to their best-returning asset class.
Many LPs were quick to realize this in 2013; they made substantial new commitments to PE funds. Fund-raising continues to be problematic for GPs with poor track records, and the level of LP scrutiny of all GP relationships remains high. But the arrow is pointed decidedly upward to healthier fund-raising levels in 2014. Overall, deal makers will have plenty of dry powder to get those new deals done.
The challenge for GPs will not be deploying capital but making good investments. Competition for deals is unrelenting. Monetary policy in the US and other developed markets continues to force investors to chase yield, and this, in turn, is making plentiful amounts of debt available for any reasonably attractive asset. The resulting effect to push up asset prices exacerbates the difficulty of penciling out winning returns. To make good deals, GPs must truly specialize—both across industries and types of deals—so they can develop distinctive investment angles and have the confidence to bid what is required to win a target asset they can transform into a highly lucrative investment.