LPs question deal pricing amid market turmoil

Attendees arrived at an industry conference in San Francisco on Feb. 12 after two weeks of market volatility caused the Dow Jones Industrial Average to plunge more than 10 percent.

Even as stocks rebounded, many LPs at the conference questioned how their private equity investments would be affected by an inevitable market downturn.

“I actually think there are some storm clouds on the horizon,” said Andrea Auerbach of Cambridge Associates, who delivered a keynote address at SuperReturn US West this week.

The average expected return of recent PE funds has fallen from the heights hit by older vintages, she said, and “the reality is that the industry hasn’t hit that 2x, 20 percent return threshold in some time.”

The lower return profile is likely due, at least in part, to the prices many larger firms are paying to acquire new portfolio companies.

Purchase-price multiples on deals valued at $500 million or more averaged more than 10x annual Ebitda each year since 2014, recent research published by TorreyCove Capital Partners shows.

The average PPM cracked 10x Ebitda just once — in 2007 — between 1999 and 2013, TorreyCove said.

Several LPs at the conference said buying high could prove troublesome if economic growth stalls or public markets slide into a sustained correction. A recent Probitas Partners survey of 98 investment professionals showed a growing fear that “the market is approaching the top of the cycle.”

“On average, LPs will be disappointed by private equity returns,” said Dignity Health Director of Investments Julia Winterson, speaking on a panel. PE portfolios can still perform well, she added, but declining returns are putting more pressure on investors to invest with a narrow selection of best-in-class managers.

“If you’re an LP, and you’re looking at GPs, figure out what they do better than anybody else,” Winterson said.

Although projected returns are expected to fall, GPs delivered roughly $900 billion in distributions over the past seven years, Auerbach told the SuperReturn audience, adding; “Holy crap, that’s a lot of money.”

With investors still searching for yield, LPs are using those distributions to make fresh commitments to new funds. As firms amass large stockpiles of dry powder for investments, Auerbach said, she expects private equity managers will soon begin to call more capital than they distribute.

“As I think about the economic environment we want to be investing in, it’s pretty challenging right now,” said Panelist Curt Futch, managing partner of special-situations firm Jupiter Peak Capital. “We need to have capital because when it does turn, we need to be ready.”

Action Item: To see the TorreyCove report, visit www.torreycove.com

The San Francisco Bay Bridge at sunset, with the city in the background, on Aug. 11, 2017. Photo courtesy Reuters/Alexandria Sage

CORRECTION: An earlier version of the story mistakenly referred to Jupiter Peak Capital as Jupiter Creek Capital.