Like listed companies, companies owned by private equity firms have fluctuations in their enterprise valuations. But the data isn’t publicly disclosed. Lincoln International, an investment banking adviser, attempts to fill that information void with its Private Market Index.
In the fourth quarter, according to the Lincoln PMI, the enterprise values of privately held U.S. companies rose 1.6%, compared with an increase of 1.9% in the third quarter and a contraction of 0.4% in the second. (See chart, Drivers of Enterprise Value.) About 80% of the 4,000 companies Lincoln tracks experienced revenue growth for 2022, and 60% grew earnings (EBITDA) for the year.
The EBITDA growth is what’s keeping enterprise valuations from shrinking, although it was not nearly as high as the increases recorded in the last quarter of 2020 and the first three quarters of 2021. Earnings (measured as EBITDA) rose about 9% over the last 12 months, but decelerated as 2022 progressed, said Lincoln International’s report.
“Looking ahead, if portfolio companies are unable to pass along costs through price increases and sustain demand tailwinds, we will likely start to see EBITDA declines across the market and a potential year-over-year decline,” said Ron Kahn, managing director and co-head of Lincoln International's valuations and opinions group.
Amid the pessimism in public and private markets, the multiples of private companies are not expanding. The multiple afforded EBITDA fell 0.7% in the fourth quarter, 0.7% in the third, and 3.4% in the second quarter. And for the four preceding quarters.
On the industry front, consumer companies experienced enterprise value declines in the fourth quarter and the full year. The Lincoln International report cited the inability to pass on increased costs fully given lower spending (especially in consumer goods) in the face of a potential recession.
Energy companies, in contrast, benefited from the commodity pricing environment, as valuations increased 12% in the fourth quarter. (See chart, Enterprise Valuations Ups and Downs.)
What does all this mean in the world beyond a spreadsheet? Less credit available to PE firms looking to buy companies, for one. Lenders to leveraged buyouts are focused on the liquidity of underlying portfolio companies, according to the Lincoln International report. In addition, higher interest rates hitting portfolio companies’ floating-rate debt will test those companies’ ability to service the debt. In 2022, according to Lincoln, PE lenders saw default rates increase to 4.2% from 2.2% year-over-year.
For this year, a recent survey of 100 asset managers by Lincoln found that 70% of respondents expected EBITDA to be flat or down in 2023 — driven by a rising expectation that price increases may not be repeatable in 2023. Two-thirds of asset managers expected enterprise values to shrink in a range of -15% to zero this year.
So a further slowdown in PE buyouts is also possible. “Sellers will hesitate to offload portfolio companies at a discount and remain preoccupied with managing portfolio company health amid a sea of rising rates and slower growth,” said Kahn. “For deals to get done in 2023, buyers may either need to adjust their return hurdles or sellers will need to reset their sale price expectations.”
The Lincoln PMI inputs come from PE sponsors and nonbank lenders.