Premium Drops? What Premium Drops?

Citi Alternative Investments today sent out a 2008 Private Equity Outlook, with such unoriginal predictions as fewer mega-deals, continued globalization and “a continued focus on strategic and operational improvements.” Yawn.

But there was one line that caught my attention: “With less leverage available, we expect to see a downward adjustment in pricing, leading to lower entry valuations that private equity firms pay for portfolio companies.”

This too echoes conventional wisdom, but not necessarily what we’ve been seeing so far in 2008. Just take this week, for example: Bain Capital offered a whopping 47% premium for Bright Horizons. Thoma Cressey offered a 36.4% premium for Manatron Inc. Warburg Pincus went 32.4% higher for LifeCore Biomedical Inc.

For some broader context, Standard & Poor’s reports that the average 2007 purchase price multiple (vs. enterprise value) for buyouts was 9.33x. That’s the highest-ever on record, and up 8.04x in 2006. Within those numbers, there was obviously a drop-off in Q3 and Q4, but not nearly as much as credit crunchers might expect. For deals of $500 million or more, it dropped from 10.56x in Q2 to 10.23x in Q3, and then dropped again to 9.56x in Q4. Still pretty high.

Purchase price multiples for mid-sized deals ($250m-$500m) actually rose between Q2 and Q3, from 9.09x to 9.31x, before settling back down at 8.69x in Q4. And then there were small-market deals, which actually rose each consecutive quarter of 2007 — finishing up at 8.86x in Q4.

The lesson here is to beware of conventional wisdom when it comes to deal premiums, even if the typical targets are indeed smaller…