Pricing and Availability of Quality Targets Are Top Challenges for Private Equity Funds in 2014, According to BDO Study
--Funds Actively Manage Portfolio Companies to Mitigate Potential Losses—
CHICAGO--(BUSINESS WIRE)--Private equity fund managers believe pricing will be their most significant challenge in 2014, according to the fifth annual PErspective private equity study by BDO USA, LLP, one of the nation's leading accounting and consulting organizations.
“While compelling investment opportunities do exist, private equity firms will need to be extra diligent as they work to find quality companies that are priced right in today’s frothy market.”
When asked to rank the challenges private equity firms will face in the coming year, 39 percent of fund managers cite pricing as their most significant hurdle, a marked uptick from just 15 percent of respondents who said the same in last year’s study. This coincides with rising purchase price multiples, which increased to approximately 9.8 times EBITDA in 2013, up from 8.3 times in 2012, according to Preqin. The second largest percentage of fund managers (34 percent) say the identification of quality targets will be their number one challenge in 2014 (up from 28 percent in last year's study), pointing to ongoing concerns about deal flow in the wake of a slow year for private equity deal sourcing.
"We’re seeing an increased number of financial and strategic buyers competing for deals, as well as increased access to debt, leaving many fund managers concerned about their ability to source and close quality deals in the year ahead," said Lee Duran, Partner and Private Equity practice Leader at BDO. "While compelling investment opportunities do exist, private equity firms will need to be extra diligent as they work to find quality companies that are priced right in today’s frothy market.”
2013: A Year of Solid Performance for Private Equity Portfolios
Despite anticipated deal flow challenges, 2013 was a robust year for private equity returns, with three-in-four survey respondents seeing the value of their entire portfolio increase during the past 12 months, an 11 percent uptick from the year prior. Only 12 percent of fund managers report a decrease in the value of their overall portfolio (down slightly from 15 percent last year) and 13 percent of respondents indicate that the value of their portfolio stayed the same in 2013 (down from 21 percent last year).
"This was a good year for private equity investors, who profited greatly from private equity funds taking advantage of a seller’s market," said Dan Shea, Managing Director with BDO Capital Advisors, LLC and a member of BDO’s Private Equity practice. "Strong exits led to private equity sponsors returning a record amount of cash last year."
Of the 75 percent of fund managers who saw the value of their portfolio increase during the past year, the largest group (49 percent) reports increases of between 6-15 percent, followed by increases of 16-25 percent, reported by 31 percent of fund managers. Another 11 percent saw increases of between 26-35 percent, and five percent of respondents report increases of more than 35 percent.
For fund managers who saw their portfolio decrease, the largest percentage (44 percent) indicate that the fund's value decreased between 6-15 percent. Another 33 percent indicate their fund's value decreased less than six percent, and 11 percent of fund managers saw the value of their current portfolio decrease between 26-35 percent and 46-50 percent, each.
Fund Managers Actively Manage Portfolio Companies
Despite a strong year for overall portfolio performance, some individual companies continue to struggle. In fact, one-in-five fund managers say more than 20 percent of their sponsored companies are performing below forecasts or expectations, and another 20 percent are seeing 6-10 percent of their portfolio companies underperform. Only 14 percent of fund managers say none of their portfolio companies are performing below forecasts or expectations.
Reinforcing findings from last year’s study, when 26 percent of fund managers ranked maintaining portfolio company performance as their most significant challenge (down to 17 percent in this year's survey), private equity firms say they are continuing to actively manage portfolio company operations to mitigate losses:
- Sixty-five percent of fund managers report that they reduced headcount for portfolio companies that are performing below forecasts or expectations, up from 58 percent last year.
- Similarly, 61 percent of fund managers say they reduced costs by scaling back, 63 percent of fund managers renegotiated debt for poorly performing portfolio companies and 70 percent are monitoring portfolio company cash flow on a weekly basis.
- The majority of fund managers (80 percent) indicate that they are reassessing market strategy for portfolio companies that performed below forecasts or expectations, up from 72 percent last year.
- Private equity fund managers are also increasingly hiring turnaround professionals, with one-quarter of fund managers indicating they did so in the past year, up 39 percent since last year.
While portfolio companies have faced losses in the past year, bankruptcy filings remain low, with only eight percent of fund managers indicating that they declared bankruptcy for one or more portfolio companies in 2013. The outlook is even brighter for 2014, with only six percent of fund managers anticipating they will have to file for bankruptcy for one or more portfolio companies.
Private Equity Reports a Mixed Outlook for Hiring
When it comes to hiring at portfolio companies, nearly three-in-four fund managers (72 percent) plan to increase professional staff headcount at the operating company level in the coming year, an increase from 63 percent who say they increased professional staff headcount during 2013.
Hiring plans at the fund level are less aggressive. The majority (54 percent) of fund managers did not increase fund employee count in 2013, and 56 percent of fund managers plan to keep hiring at bay in the coming year.
These findings are from the fifth annual BDO PErspective Private Equity Study, which was conducted from November through December 2013 and examined the opinions of more than 100 senior executives at private equity firms throughout the U.S. with $30 million to $70 billion in assets under management.
Other major findings from the BDO PErspective Private Equity Study include:
- Limited Partners Still Hold Track Records in High Regard: Reinforcing concerns about succession plans for large funds, the majority (62 percent) of survey respondents believe that a fund's track record is the most important factor for limited partners (LPs) when evaluating general partners (GPs), down slightly from 67 percent last year. Operating experience was the second most popular choice, with 19 percent of fund managers viewing it as the most important factor (up from 12 percent last year), followed by 13 percent of fund managers who believe LPs prioritize a fund's management team.
- Funds Consider Changes to Fee Structure, Transparency To Attract LPs: When it comes to making funds more attractive to LPs, 22 percent of private equity fund managers are considering changing fee structures (i.e., decreasing management fees, introducing new fee structures, etc.), followed by 14 percent who are increasing disclosures and transparency to LPs, 13 percent who are changing philosophy with regard to investment type (i.e., mezzanine, equity, etc.) and 13 percent who are not making any changes to their strategy.
- Funds Take a Wait-and-See Approach to the JOBS Act: In reference to the JOBS Act, the majority of private equity fund managers (71 percent) remain reluctant to change their plans or policies regarding general solicitations. Only 10 percent of fund managers plan to update their procedures to verify investor accreditation and a mere four percent plan to publicize past performance or hire an in-house marketing or media professional. Diverging slightly from the majority, 13 percent of fund managers with AUM between $250-500 million are more likely to opt-in via Form D filed with the SEC to begin solicitation, and 13 percent plan to hire an in-house marketing or media professional.
The BDO PErspective Private Equity Study is a national survey conducted by PitchBook, an independent and impartial research firm dedicated to providing premium data, news and analysis to the private equity industry. More than 100 senior executives at private equity firms throughout the U.S. with $30 million to $70 billion in assets under management responded to BDO's latest study, which was conducted from November through December 2013.
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