For two years, conventional wisdom was that private-equity firms would be compelled to resume the burst of deal-making activity they undertook before the financial crisis. PE firms would have to put their growing reserve capital to use or lose it, the theory went. But in the second quarter, their merger-and-acquisition activity continued to slump.
U.S. private-equity firms mostly sat on their hands in the first half of 2012, according to data published last week by Pitchbook, an independent private-equity deals database, and Merrill Datasite, a provider of virtual data-room services.
Both deal volume and dollars invested by financial sponsors in the United States fell last quarter, and the $51 billion invested was the lowest total since 2009. Year-over-year, transaction numbers dropped 39%, and PE firms are on a pace to do only 1,332 deals in 2012, the fewest since 2003.
“While the health of the overall economy is up for debate, PitchBook’s data show that PE investment is going through an undeniable slowdown,” the firm said in its report. “All of a sudden the outlook seems more gloomy.”
Yet investors continue to allocate money to this alternative asset class, adding to the industry’s almost half a trillion dollars in “dry powder.” Thirty-three PE funds closed in the second quarter, raising a total of $35 billion, the second-best quarter in three years. In addition, funds greater than $1 billion are increasing as a proportion of overall funds.
According to an investor outlook report by alternative asset-research firm Preqin, almost 75% of limited partners globally anticipate committing more or the same amount of capital to PE funds this year, and a quarter plan to allocate more capital than in 2011.
Investor interest is probably warranted, given the return PE investments have earned relative to other assets. Combining data from several sources, including Cambridge Associates and Thomson Reuters, the Private Equity Growth Capital Council, a lobbying group, says the five-year-return on pension funds’ private-equity investments was 7.7% at the end of 2011, compared with zero return for the S&P 500 index. On some shorter time lines, however, public markets have outperformed. (Year-to-date, the S&P 500 Index has returned 11%.)
More than three-quarters of the limited partners (LPs) surveyed by Preqin say their PE investments have performed as expected, and 9% feel PE returns have exceeded their forecasts. The majority of LPs, according to Preqin, expect returns of more than 400 basis points above public markets, while 23% expect returns 200 to 400 basis points above.
But unless an investor sells its stake in a PE fund in the secondary market, realizing those returns requires PE firms to exit their investments at some point, and that has not been easy. The number of exits fell in the second quarter, to the lowest level since the first quarter of 2011. And the amount of exited capital dropped 42%, even though, says Pitchbook, there were several large exit deals. Each of the transactions involving SonicWALL, Burger King Worldwide, and Solo Cup, for example, topped $1 billion.
By industry, more PE firms have exited deals in energy and financial services this year, but the number of deals in which PE investors sold health care, consumer products, and business-to-business assets lagged historical norms.
PE firms’ appetite for consumer businesses has waned in the past year (transaction volume was flat year-over-year), but 35% of M&A transactions in the first half of 2012 have been among business-to-business companies, a rise of six percentage points.
“With renewed talks of recession, PE firms seem to be following suit with the rest of the investing world, focusing on business-related companies and inelastic commodities,” said the Pitchbook report.