Some buyout deals hit a rough patch in 2022, but history suggests that down is not out
Some buyout deals hit a rough patch in 2022, but history suggests that down is not out
Early losses can distract from the bigger picture. Buyout deals closed within the past six years have been subject to large write-downs, reporting losses due to volatility caused by the COVID-19 pandemic, inflation, and Russia’s invasion of Ukraine. Despite these headwinds, the good has mostly outweighed the bad. That is, if funds can report residual asset values before distributing capital to LPs.
Losses mounted in the first year for deals with 2019 vintage. These deals, made before the outbreak of COVID-19, experienced a sharp and sudden market decline in their first year. Analysis of Preqin’s Deal Performance Benchmarks shows just how bad those early write-downs were. In the first year after close, the median loss ratio for US buyouts in this vintage was 6.2% of total dollar value (Fig. 2). This means that deals with 2019 vintage rank second only to 2009, for which the median loss ratio was 13.8%. High loss ratios were also reported for vintage years 2016 (4.8%) and 2017 (3.2%), putting those vintage years in the top five, ranked by initial three-year loss ratios, from the past decade. But with most of these deals’ NAVs yet to be realized, or distributed back to investors, these losses are far from final. While this does open the door for the managing funds to find value, the window remains open for further losses.
As these vintages age, we can see the same years linger near the top of the rankings, but only 2017, saw a significant upward shift in its loss ratio. The median loss ratio for 2017 vintage deals jumped from 3.2% in the first year since inception to 9% in the third year since inception (Fig. 3). The 5.8 percentage point increase was well ahead of the average 2.7 percentage point increase for deals since 2009.
Each deal faces a unique combination of factors that will influence its eventual performance. But the hope is that GPs can manage internal and external risk factors to extract the most value from assets, relative to their situation. And in general, they’ve done that. Loss ratios reported early in a deal’s investment lifespan don’t appear to strongly influence eventual performance (Fig. 4). Some of the best-performing vintages rode waves of low interest rates and upward bound equity markets, eventually overcoming early losses.
For LPs concerned about their latest commitments in this current market downtrend, there’s still time for deal value to recover. By dividing the residual value paid in (RVPI) for the median deals for a given vintage year by the total value paid in (TVPI) for the median deal of that vintage year, and expressing that value as a percentage, we can see that in the more recent vintages in the range from 2015 to 2022, a large proportion of value is yet to be distributed. For deals made in 2018 and after, more than half their values have yet to be distributed back to LPs (Fig. 5).
So where do these deals stand?
Performance data from buyouts made this year is too new to draw any conclusions. But deal valuation data shows that GPs are paying far less than in 2021. Preqin benchmark data shows that the average EV/EBITDA GPs paid for a US buyout deal fell to 15.3x this year, from 18.9x in 2021. And the 2021 vintage has seen the most significant increase in loss ratio through the first nine months of the year. Buyout deals made during the height of the pandemic in 2019 have had the hardest journey across the sample set, reporting a median 7.7% loss ratio as of September 30, 2022 (Fig. 6).
Loss ratios for buyout deals with 2019 vintage were extremely high, which could be due to volatility between 2020 and 2022 in the wake of the pandemic. However, loss ratios for later vintages are much lower (Fig. 7) so far. The data also shows that loss ratios for each vintage year increases to a plateau in Q3, after a sharp increase from Q1 to Q2. As we’ve seen, tumult and write-downs in the initial years of a deal’s life will not always have a marked impact on a deal’s end return.
Managers can still find value for their clients. Performance will always reign supreme for allocators and the way that managers navigate the buyout arena will build and erode reputations equally.
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