In 2022, a majority of investors viewed private equity as overvalued. However, by 2023, less than half of those surveyed held that belief, marking a significant shift in sentiment. The proportion of limited partners (LPs) who considered private equity to be considerably or somewhat overvalued decreased by 20% compared to the previous year’s survey. Merely 6% anticipate significant potential for further reduction, while 39% believe there is room for adjustment.
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Are private equity valuations too high?
While private equity valuations have raised eyebrows for appearing relatively high compared to their public market counterparts, industry experts argue that these valuations are appropriate. Beyond mere multiples, private equity’s success is anchored in factors such as revenue growth and margin expansion, which are the primary drivers of value creation within these portfolios. Figures from StepStone Group LP’s analysis revealed that, on average, private equity revenue grew 4.1% annually, more than the S&P 500, demonstrating the sector’s ability to generate substantial growth despite market fluctuations. Moreover, data shows that private equity consistently outperforms public markets, with current-cycle buyout funds generating a direct alpha of 10.8%. These figures underscore the resilience and efficacy of private equity strategies, which have historically delivered strong returns over time.
Sharp decline in deal volume and contracting valuation multiples
Deal flow continued its downward trend in 2023, marking the second consecutive year of decline with a 24% drop in volume and a substantial 30% decrease in value compared to 2022. This downturn represents the most prolonged declining activity since the great financial crisis. Although the number of completed deals in 2023 was 20% higher than in 2019, pre-COVID-19, the aggregate deal value fell below the 2019 high-water mark. Alongside declining deal volumes, private M&A multiples saw a regression in 2023. After fluctuating over the past year, EBITDA multiples have realigned with historical levels observed between 2017 and 2020, indicating a transition towards correction mode. The peak year for middle-market private company valuations was 2021, with multiples reaching 13.5x. However, they have since trended closer to the historical average of 11.4x, suggesting a contraction in valuation multiples.
Fundraising trends and future
In 2023, private equity fundraising reached $1.2 trillion, contributing to the industry’s $7.2 trillion capital accumulation since 2019. However, it marked a 20% decline from 2022 and nearly 30% from the 2021 peak, reflecting LPs’ cash flow constraints. Only buyout funds saw an 18% increase, while secondaries surged by 92%. The year also saw larger fund sizes, with LPs favoring established funds. Despite the decline in fund numbers, competition for capital intensified, with a supply/demand mismatch. LPs remain optimistic about private equity but face cash flow challenges, raising concerns about future allocations.
Outlook for 2024
Private equity ended 2023 strongly, with firms announcing deals worth US$124b in Q4, marking the most active quarter by value. Despite inflation and rising interest rates, PE firms remained resilient, anticipating increased activity in distressed transactions and secondary buyouts in 2024. Tech, consumer, financial services, and health sectors remain attractive for investment, focusing on operational value-add amidst higher interest rates. Private credit is expected to continue dominating financing while sustainability gains traction as a value-creation lever. Firms with flexible strategies are poised to capitalize on opportunities in the evolving investment landscape.
Conclusion
In conclusion, despite fluctuations in deal volume and valuation multiples, private equity continues to demonstrate its resilience and value proposition. The recalibration of valuations, supported by strong revenue growth and margin expansion, underscores the sector’s ability to deliver consistent returns over time. Looking ahead, firms with flexible strategies are poised to capitalize on opportunities amidst market challenges, driving innovation and value creation in the evolving investment landscape.
References
- https://www.stepstonegroup.com/wp-content/uploads/2023/04/Are-Private-Equity-Valuations-Too-High_.pdf
- https://www.cbh.com/wp-content/uploads/2024/02/TL_Report-PE-Review-2023-1.pdf
- https://www.ey.com/en_tr/private-equity/pulse
- https://www.bain.com/globalassets/noindex/2024/bain_report_global-private-equity-report-2024.pdf