Corporate Financing Analysis - Buyout Tailwinds Driving Global PE Spending Surge - 06 NOV 2017

As we move into the final two months of the year, 'animal spirits' are alive and well in the global buyout arena, with funds taking advantage of investor confidence to snap up new assets having completed a wave of exits over recent years. Furthermore, in the current 'sellers' market', private equity funds across the globe have been taking advantage of the favourable conditions for dealmaking to sell off an ongoing flow of portfolio units - albeit not quite at the rapid pace as seen over recent quarters. Looking ahead into H118, we expect that buyouts will continue to make the headlines thanks to, firstly, the record amounts of dry powder available to funds operating in the asset class at present and which needs to be put to work in order to get investors on side; and secondly, the new opportunities being created as valuations begin to drop when interest rates begin to rise once more and access to cheap financing subsequently fades, making the dealmaking arena less competitive than it has been for PE firms so far this year.

Asia Closing The Gap On US
Q317 PE-Backed Buyout Deals By Region, By Deal Value USDbn
Source: Preqin , BMI

So, why are conditions so ripe for buyouts at present? BMI points to three key factors: firstly, PE firms remain sat on large mountains of dry powder, supported by the swath of exits seen over recent quarters; secondly, investors have been buoyed by the stabilisation in global economic growth - especially in emerging markets - and the lower levels of geopolitical volatility than experienced over the past couple of years; and thirdly, the prolonged period of cheap financing which has helped support the swelling of PE funds to record sizes, with a growing number of institutional investors, and in some cases, sovereign investors now on board. The most obvious example of this is Japanese multinational Softbank's high-profile, tech sector-focused 'Vision Fund' ( see 'Deal of the Week: Softbank Raising Tech Investment War Chest', May 11 2017) which has raised USD100bn, making it the largest PE fund close of all time. We highlight that backers of the fund include Abu Dhabi's Mubadala Development Company, Saudi Arabia sovereign wealth fund (swf), and corporate giants such as US multinational semiconductor and telecommunications firm Qualcomm and tech behemoth Apple.

The Bullish Buyout Arena

According to data from research house Preqin, the global PE-backed buyout industry saw Q317 deal activity almost on par with that of the previous quarter, with 953 deals announced worth an aggregate USD92bn. In Q217, 1,047 deals were recorded worth a combined USD93bn. Thanks to back-to-back quarters of elevated deal levels compensating for the lack of activity in the first quarter, which equated to the slowest quarter for dealmaking since 2012, 2017 now looks set to remain on course to record aggregate deal values similar to 2016. Despite all of the tailwinds supporting activity in the PE space, we acknowledge that the competition with strategic acquirers for assets ( see ' PE Buyouts Struggling To Compete With Strategic Acquirers ' , May 10 2017) has held deal levels back from what they could have been, given the level of dry powder of PE fund books at present.

In terms of the geographic spread of announced deals in the third-quarter, the asset class' spiritual home of North America remained the most popular destination for buyouts, both in terms of deal value and deal volume. Indeed, Preqin shows that the region was home to 513 deal worth a combined USD36bn during the three-month period ending September 30; however, North America also saw the largest decrease in deal activity from Q217, with aggregate deal value dropping from a level of USD62bn. Interestingly, this level of dealmaking only just outpaced the recent surge of interest in Asia, where 39 deals were announced worth a combined USD32bn across the same time period and, by stark contrast, Asia buyout activity was up by as much as USD23bn q-o-q. Europe, meanwhile, remains the global laggard in the rankings, recording 350 deals during Q317 worth a combined USD20bn. BMI highlights that Asia's closing of the gap on North America's - and in particular, the US' - long-standing dominance of dealmaking in the PE space adds credence to our view that the maturing and expansion of the Asian buyout industry is ongoing. In particular we point to the region's jump in average deal value, as supported by the region playing host to the two largest announced deals of the third-quarter, which alone were worth a combined USD30bn. The largest deal to be announced during the last quarter also ranks as the largest Asia-focused buyout deal on record: the JPY1,000,000mn buyout of electronics firm Toshiba Memory Corporation, the semiconductor business of the Toshiba Corporation parent group, by a Bain Capital-led consortium which includes investments from tech giants Seagate, Dell, and Apple. This was followed by the public-to-private purchase of Singapore's Global Logistic Properties for SGD16,000mn by a group of acquirers headed by Bank of China Group Investment. Away from the recent buyout boom in Asia, the third largest PE investment of Q317 was in the US where Access Industries, CPP Investment Board, and Energy Capital Partners all joined forced to snap up electricity generator Calpine Corporation for USD5,600mn in another public-to-private transaction. In fact, we highlight that such corporate carve-out deals are becoming increasingly commonplace, with Preqin data showing that 26% of aggregate deal value in Q317 was accounted for by public-to-private deals.

Exits Slowing But Still Ongoing

While we believe that it remains a sellers' market at present, PE exit deal levels are not hitting the headlines in the same way that buyouts at the opposite end of the investment cycle are doing. Indeed, Preqin data show that buyout-backed exits tallied USD65bn across 381 deals during Q317. While this represents the fifth consecutive quarterly decline by deal volume, we note that it represents only the first quarter of decline by deal value. BMI points to three key factors which are catalysing this downturn in activity: first off, with valuations sky-high, the M&A arena has become increasingly competitive ( see 'PE To Be Priced Out In 2017 M&A Rally', February 8 2017); secondly, PE funds globally have, broadly speaking, successfully sold off a large number of vintage assets this year, thus alleviating some of the pressure for them to make exits and return cash into the cash of investors who waited patiently for returns in the aftermath of the global financial crisis; and thrirdly, funds are now hanging onto portfolio assets for longer than they were previously, extending the typical three-to-five-year investment cycle for PE investments.

Within the downturn there has still been plenty of room for deals, however. Preqin data show that the largest exit deal of the quarter was the sell-down of US-based telecoms firm Lightower Fiber Networks to telecoms infrastructure provider Crown Castle International Corporation (CCIC) for USD7,100mn (including debt) by a consortium of six investors that included Wall Street giant J.P. Morgan, providing them with a profit on the USD1,900mn investment they made in the firm back in April 2015. Meanwhile, the largest deal to be announced outside of the US market last quarter was Hong Kong-based Cheung Kong Property Holdings Limited's acquisition of German energy firm Ista International GmbH for EUR4,500mn, a mark-up from the EUR3,100mn the asset was originally bought for by investors CPP Investment Board and CVC Capital Partners back in April 2013.

Secondary Buyouts Back In Vogue

Beyond the bumper deals, we highlight that a trend which has been gaining momentum fast in the PE exit market has been for secondary buyouts, whereby portfolio assets are sold by one buyout fund to another. In our view, such 'pass the parcel' deals provided an ideal outlet for the record amounts of dry powder in the PE industry at present, which Bloomberg put a at a level of USD963.3bn as of the end of H117, and which may otherwise struggle to be spent in the competitive M&A climate characterised by high deal valuations. The largest example of this in Q317 came in the form of Cinven's exit of patent management services firm CPA Global, passing on the asset to Leonard Green & Partners for GBP2,400mn - a price more than two-fold the initial GBP950mn investment the former made in the firm back in January 2012. Within this, we point to an emerging trend in which a growing number of PE funds from the middle or lower end of the market are selling on assets to those with greater funds, allowing them to go on and unlock further value from the assets as they continue to grow ( see ' PE Funds Begin Passing The Parcel With Increasing Frequency ' , August 23 2017).