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US $214 billion
The value of US buyouts in 2018—up 7 percent compared with 2017
Deal figures have held their own despite growing edginess within the buyout community about high valuations, especially with growing pessimism about the economy towards the end of the year.
Given the high levels of dry powder at their disposal, firms remain under pressure to put their money to work, but with valuations so high, many private equity investors may welcome a correction.
Given these market dynamics, firms have become increasingly cautious, as even the smallest bumps in the road can negatively impact returns. After all, high multiples, and the added leverage this usually implies, mean increased risks to any investment.
Companies may find themselves with less margin for error in such circumstances, making covenant defaults more likely. And if there is a multiple contraction, even well-performing companies may deliver a poor or negative return on investment.
Weighing these factors, smart investors should proceed cautiously to avoid overpaying in what may be the tail end of an expansion period.
Competition for quality
Given these risks, firms have focused their resources on buying assets with proven track records of trading through cycles, as seen when Blackstone, GIC and the Canada Pension Plan Investment Board teamed up to acquire a 55 percent stake in Thomson Reuters’ Financial & Risk business for US$17 billion.
Firms have also clustered around resilient, high-growth sectors when seeking out targets. The technology sector has proven particularly attractive in this respect, thanks to its disruptive capacity. Investors have seen that high-quality tech companies can sometimes enter new industries and quickly take disproportionate market shares, making this sector a favorable investment target in an uncertain environment.
In order to manage higher multiples, firms are also looking for adjacent areas where pricing and competition aren’t as acute, such as infrastructure and real estate.
PE turns to infrastructure
In order to manage higher multiples, firms are also looking for adjacent areas where pricing and competition are sometimes not as acute, such as infrastructure and real estate. Within infrastructure, investors are drawn to areas ripe for consolidation, where they can deploy a platform play, consolidating smaller operations before selling to a large investor or strategic buyer for a higher multiple.
Conundrum for the coming year
Deployment has also been informed by previous successes, with firms seeking to replicate exits like the Sequoia Capital–led consortium selling tech business GitHub to Microsoft for US$7.5 billion and KKR’s exit of Sedgwick Claims Management to The Carlyle Group for US$6.7 billion.
Against a backdrop of sky-high valuations and growing unease about macroeconomic trends, buyout firms are feeling cautious, yet must deploy the vast amount of committed capital they have. This is the conundrum most firms will be facing in the coming year.
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