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Optimism replaces years of frustration
After four frustrating years of false starts, nervous capital markets and deal-dampening volatility, the private equity (PE) industry has taken a sharp turn from uncertainty and worry to enthusiasm about the past year and optimism for the future
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After four frustrating years of false starts, nervous capital markets and deal-dampening volatility, the private equity (PE) industry has taken a sharp turn from uncertainty and worry to enthusiasm about the past year and optimism for the future.
A year of calmer macroeconomic conditions set the stage for PE's revival in 2013 and laid a foundation for further expansion in the year ahead. As we describe in this year's edition of Bain & Company's Global Private Equity Report, PE investors profited from strong public equity markets and enjoyed the persistent low interest rates and accommodating debt markets the central bankers helped engineer.
Exit channels opened up. New initial public offering (IPO) issuance, follow-on offerings and dividend recapitalizations were robust, enabling general partners (GPs) to increase distributions to limited partners (LPs) as they cashed out a long pipeline of past investments.
As new money flowed back into their coffers, LPs were able to refresh their PE commitments, breathing life into GP fund-raising campaigns. With many of the once-troubled deals from the mid-decade boom years profitably sold and the valuations of unsold assets still in GP portfolios climbing, PE returns rebounded.
The factors that helped make exits, fund-raising and returns flourish, however, also made 2013 a challenging year for deal making (see figure). They raised the floor on sellers' price expectations, making deals that did get completed more costly and pushing some deals out of reach of PE acquirers.
The allure of IPOs also siphoned away companies that might have gone to auction, shrinking the pool of potential deals.
The signs of strength we spotted in late 2012 and discussed in Bain's 2013 private equity report fanned an upswing in GP and LP sentiment during the past year. Improving macroeconomic conditions in the developed markets and the favorable consequences they had for investors helped boost confidence. Top-performing GPs capitalized on these favorable conditions by savvy deal making, well-timed exits, smart fund-raising and continued delivery of solid long-term returns.
The PE market is primed to continue to expand and prosper in 2014 and beyond. The number of new investments will likely pickup, but absent an unexpected revival in big public-to-private transactions, deal value will probably not increase significantly. As investment activity advances, GPs will profit from what they learned from past successes and failures to make better deals in the years ahead.
The hard work they have put into grooming their portfolio companies for profitable exits will pay off as they aggressively harvest the remaining crop of investments made at the height of the last boom. The liquidity and solid gains they reap will, in turn, support stronger fund-raising and fund returns.
This vision of a bright future comes with a few caveats. Modest investment activity in 2013 combined with stronger fund-raising has swollen already vast stores of dry powder to more than US$1 trillion. Barring an upsurge in assets coming up for sale, the excess capital will ignite intense competition and keep asset prices high.
Volatility in the capital markets could paralyze deal making on both the buy side and sell side. GPs' hunger to raise new funds, meanwhile, continues to exceed the amount of capital LPs are able to feed them.
Faced with this unstable situation, many PE firms are making sweeping changes in their strategies, away from a single-minded pursuit of growth to a focus on differentiation.
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Hugh MacArthur, Graham Elton, Bill Halloran and Suvir Varma are leaders of Bain & Company's private equity group. Read the full report: Global Private Equity Report 2014.
