2017 US Middle-Market Deal Flow Closely Mirrors Broader Trends of Private Equity
February 01, 2018
SEATTLE, NEW YORK, SAN FRANCISCO, LONDON – February 1, 2018 – In 2017, private equity (PE) firms invested $324.1 billion across 2,306 middle market (MM) deals, according to the 2017 PitchBook U.S. PE Middle Market Report. Last year finished strong with a 14% year-over-year increase in deal value, largely attributable to the substantial shift in activity towards the upper middle market (UMM). The UMM saw a 46% increase in deal value and a 62% increase in deal volume, year-over-year, whereas capital invested in the lower and core middle market dropped 19% and 12%, respectively. Since most PE activity occurs in the MM (deals of $25 million to $1 billion), it is unsurprising that this constituency mirrors many of the same trends that are seen broadly across this asset class: deal flow remains flat, exits are trending downward, and fundraising continues incessantly. As noted in the 2017 PitchBook M&A Report, last year saw a major slowdown in strategic acquisitions – which had substantial ramifications for the PE exit market, with $89.8 billion in value across 934 MM exits, representing YoY decreases of 11% and 6%, respectively. Similar to the PE industry as a whole, fundraising for the MM held strong throughout 2017, with $121.9 billion raised across 174 funds – 33% of which was closed in 4Q alone.
“The notable shift in the US MM towards UMM activity is being driven by several factors, including record-high pricing multiples, larger add-on deals, and ballooning fund sizes,” said Nico Cordiero, analyst at PitchBook. “In 2018, if the economy continues to chug along at its current pace, we expect to see a resurgence in strategic activity, as corporations complete the integration of previous acquisitions into existing operations. The result could have a far-reaching impact on the overall PE dealmaking landscape.
Secondary Buyouts Make Up for Decline in Strategic Activity
The slowdown in strategic acquisitions in 2017 caused a corresponding downtrend in the PE exit market. While strong on a historical basis, corporate acquisitions of MM PE-backed companies represented only 45% of exits in 2017. Strategics acquired only 421 PE-sponsored MM companies, accounting for $49 billion in value; however, the IT sector bucked this trend with a 9% increase in activity. Secondary buyouts (SBOs), on the other hand, constituted 51% of all exit volume – the highest proportion recorded in PitchBook’s dataset. As noted in our 2018 Private Equity Outlook, it is likely that PE-to-PE transactions will continue to flourish given the abundance of dry powder, stagnant deal flow, and the need for liquidity as portfolio company inventories continue to age and grow. Despite sliding exit activity, median hold-times fell from their post-financial-crisis high, providing another indicator of a healthy private market ecosystem. In 2014, median hold times reached 5.7 years as PE firms were forced to hold acquired companies at elevated multiples until market dynamics recovered. At the end of 2017, the median hold-time fell to 5.0 years.
Elevated Pricing Environment Encourages UMM Activity, Add-ons
Despite a pullback in strategic acquisitions, competition remains prevalent for dealmakers. As a result, the median valuation/EBITDA multiple continued at its elevated level of 10.4x, and the median debt/EBITDA multiple reached a record high of 5.6x. Since 2013, the majority of acquisitions in the MM have been add-ons to existing companies in PE firms’ portfolios. While this proportion reached a peak of 59% in 2015 during the global M&A boom, it has since trended downward to 55% in 2017, but is likely to remain as a dominant strategy in the US MM. Add-ons provide a way for PE firms to boost revenue and earnings growth in the current environment of low-growth and elevated purchase-prices. Previous research suggests that add-on deals generally transact at lower multiples than platform companies. Therefore, in this elevated pricing environment, add-ons serve as a means for PE firms to average down the overall acquisition multiple of a platform company.
Robust Fundraising Will Keep Competitive Pressures High
Competition in the space is bolstered by the US MM’s impressive fundraising streak, with MM funds raising over $100 billion in commitments every year since 2013. Two data points underscore the fundraising fervor that has failed to slow over the last few years. First, the median MM fund size rose to $413.5 million, an 18% increase since 2013. Second, the median time to close a MM PE fund dropped from 15 months to 7.5 months from 2016 to 2017 – a 50% YoY decrease and the fastest time to close recorded in PitchBook’s dataset. The enthusiasm for this asset class is unsurprising as PE funds recently have provided strong distributions to investors who now need to re-invest that capital.
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