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Are private equity EV/EBITDA purchase price multiples a concern?

The short answer is yes.


It is becoming ever harder for investors, whether LPs committing to GPs, or GPs investing in underlying assets, to tell what is true quality. And both funds and investments that should not are getting funded.


For LPs this, at the very least, has three implications

  • Doubling down on due diligence and manager selection. In particular trying to understand where returns come from and what drives them

  • Paying particular attention to portfolio construction. Not least vintage diversification, which has been sorely neglected by many in the past few years

  • Possibly, given many GPs won’t, slowing down their investment pacing


GPs, though overall somewhat less prone to suffer from FOMO than LPs, should of course also be mindful of the same three points.


Sky-high asset prices are the biggest challenge PE investors face in generating returns[1]

Drivers of higher private equity purchase multiples include

  • A flood of capital in to the asset class from both new and old investors;

  • Increased competition for assets;

  • Easy fiscal and monetary policy; and

  • A benign debt environment


The effect of this can be seen in Figure 1, below. Almost 60% of US buyout deals are above 10x EV/EBITDA and 10% is above eye-watering 30x EV/EBITDA.


2019 was even more extreme with almost 70% of deals with multiples of 10x or more, while 2018 was roughly similar. These vintages are way beyond the vintages leading up to the GFC, which is the usual benchmark for excess in private equity.


Figure 1: US buyout EV/EBITDA purchase price multiples

Private equity multiples

Source: PE Compass, data from Pitchbook Q4 2020


High purchase multiples should be keeping investors up at night

Even as GPs increasingly have been buying growth, which all else equal, tend to trade at higher multiples, the question investors should be asking themselves is:


“How do you exit deals at these types of multiples, is that even realistic, and who will buy them?”


No wonder this is keeping investors awake at night, even as GPs tell them not to worry!


To make this point, most GPs will have a chart showing how they buy below the market average. And will , based on that, argue they don’t buy at those elevated multiples.

 

However, there is good reason for investors to worry, because Figure 1 is only half the story!


The other half, showing examples of those charts and why GPs may still be buying expensive, follows in my next post.


In the meantime,


Stay illiquid!


Kasper


[1] Source: Preqin Dec 2020

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