The Results of the RSM McGladrey and McGladrey Capital Markets 2010 Managing Portfolio Investments Survey Are In: Private Equity Industry Leaders Expect Upswing in 2010 (View complete report)
For private equity firms, 2010 should see significant improvements over 2008 and 2009, with more dealmaking activity, improvement in portfolio company revenues and profitability, and in some cases even staff increases at both portfolio companies and within private equity (PE) firms themselves.
However, obstacles remain. Raising capital and obtaining debt financing will continue to pose challenges, and relationships between some funds and their limited partners will be tense.
This assessment is based on findings of an annual survey of senior-level executives from some of the nation’s top middle market PE firms. The survey, conducted by RSM McGladrey and McGladrey Capital Markets, involved polling 148 executives from buyout, mezzanine and venture capital firms earlier in the year.
The firms’ 2009 survey found that PEGs had largely suspended dealmaking and fundraising and instead were focusing intensely on strengthening portfolio company financial performance—reducing employee headcounts, improving business processes and reducing capital spending. By contrast, this year more than half of respondents (56%) expect to complete two to five add-on acquisitions, and almost half (43%) plan on completing at least two platform acquisitions. Almost one in 10 (9%) plan to add six or more platform companies to their portfolios.
“While challenges remain, the consensus is that we have weathered the worst part of the storm and should see notable improvement for the remainder of the year,” says Bob Jensen, managing director with RSM McGladrey and a leader in the firm’s private equity practice. “It will take a while before we witness the huge returns of a few years ago, if ever, but portfolio company performance is steadily improving, and we’re seeing a return to dealmaking, particularly in the lower middle market.”
Also in contrast to last year’s study, only 8% of the PE executives surveyed expect staffing levels to decrease at the portfolio companies, compared with 31% who said portfolio company staffing levels will likely increase (61% said staffing levels will remain constant). More than one in five respondents said staffing levels will increase at PE firms themselves; only 2% expect a decrease.
“Almost everyone we surveyed expects portfolio companies to grow revenue in 2010, and the overwhelming majority predicts improvement in portfolio profitability,” Jensen said. “They’ve made the difficult cuts and are now focusing on growth—whether organic or through acquisitions.”
While deal activity is expected to increase, raising capital and obtaining acquisition debt financing continue to be significant impediments to completing transactions.
“Raising equity capital is still challenging, largely because private equity, as an asset class, has suffered declining investment returns,” said Hector J. Cuellar, president of McGladrey Capital Markets. “However, pension funds and other LPs are continuing to invest in private equity, with lower middle-market funds being the primary beneficiaries.
“At the same time, many funds still have a fair amount of dry powder they’ve yet to deploy, and the debt financing picture is steadily improving. I wouldn’t say debt is easy to obtain, but it is becoming more available, and many lenders are permitting significantly greater leverage on some transactions.”
Other challenges cited by survey respondents include sellers’ unrealistic valuation expectations (29%) and lack of attractive acquisition candidates (26%). Cuellar expects current improvements in conditions to continue.
“As debt financing becomes more available, private equity buyers will be able to offer higher multiples, which in turn will attract more high-quality sellers to the market,” he said.
A significant concern among survey respondents is the relationships between PE firms and their investors. More than three out of four respondents (76%) are at least somewhat concerned about the implementation of claw back provisions; almost one in three (32%) are very concerned. Moreover, 67% of executives surveyed expressed concerns about changes in management fees; 25% said they were “very concerned.”
In addition, more than 90% of respondents expressed at least some agreement with the statement, “We are experiencing investor partner defaults and withdrawals,” with 71% indicating they “strongly agree” with the statement.
“When PE funds were delivering double-digit returns, investors were less concerned about management fees and tended to give general partners the benefit of the doubt. But when portfolio company performance declined and investment returns suffered, LPs became noticeably less tolerant,” said Jensen. “Most institutions suffered hits in all asset classes and are now under pressure to rebalance their portfolios. Some are even facing concerns about solvency. But private equity will maintain a position in most institutional portfolios. ”
Want to read more? View the complete report now