The total value to paid-in capital ratio – a key indicator – shows North American buyout deal valuations have slid from 1.9x to 1.6x in the past five years
The total value to paid-in capital ratio – a key indicator – shows North American buyout deal valuations have slid from 1.9x to 1.6x in the past five years
For a decade, North American buyouts have outperformed their global peers. From 2011 to 2020, the mean total value to paid-in capital (TVPI) for North American buyout deals was 2.2x invested capital, ahead of both Europe (2x) and the broader universe (2.1x). But as the market matures, there are an ever-increasing number of players, intensifying competition, and higher prices for deals. That’s weighing on returns. At the same time, other regions – such as Europe – are catching up.
Let’s start with a look at the data. Using Preqin’s asset level benchmarks, we can divide the buyout market by region across the years (or range of years) deals were completed, and track their collective performance. The key indicator here is the total value to paid-in capital ratio (TVPI), a metric which allows the valuations of deals to be compared across a 10+ year period. TVPI takes into account both realized and unrealized valuations and divides that sum by the total invested capital. All figures are gross of fees, given that the valuations are taken at the asset level, rather than at the fund level.
The average TVPI for North American deals completed in 2020 has fallen to 1.6x, compared with 1.9x just five years before (Fig. 1). And at a time when North American buyout performance is declining, Europe is on the rise. Performance multiples from the continent have closed the post-GFC gap with their American peers, even outperforming in 2016 and 2019.
What’s driving this shift in performance? To understand what’s happened and how we got here, let’s look back at how private equity has performed globally over the past 15 years.
Buyouts’ post-GFC high
Recovery from the GFC and the following years of low interest-rate policies fostered an environment in which private capital could thrive. As such, deals made between 2011 and 2013 performed very well. Globally, it was the best among the three-year sample periods taken with a median TVPI ratio of 1.95 at the most recent reporting date (Fig. 2).
This set was followed by those closed between 2014 and 2016 – the most recent TVPI multiple for those funds was 1.86.¹ What drove this performance and how do those factors compare to today?
Beginning with interest rates, central banks dropped their policy rates off a cliff in the early innings of the GFC, and kept them low for the better part of six years to spur continued growth. In the US, the Federal Open Markets Committee didn’t hike its base rate until late 2015 and created a lot of runway to leverage deals (Fig. 3). Results from these early investments were encouraging as these strategies outperformed both previous vintages and public markets. This success brought more demand to a market that could only supply so much and saw the average deal – or entry price – rise (Fig. 4).
That’s creating a more challenging environment for North American buyouts. The margin of error for deal selection has declined globally, yet remains comparatively high for North American deals (Fig. 5). As the performance gap between the first and third quartile deals (the interquartile range) has fallen from 2015 highs, the probability of a NA deal performing in the top quartile, or even above the median, is lower. The spread of NA buyout deals between the middle TVPI quartiles was 1.32 in 2020, a 10-year low, still ahead of European deals’ 1.01, and the 1.13 global average.
Due diligence essentials
What does all this mean for the buyout investor? First, return expectations may have to change. Should buyout deals perform below their past trends, and the variability between them remain high, the case for lower-cost public equity options becomes more viable.
Second, investors can’t afford to be complacent. Rather than relying on past performance, LPs will need to conduct more comprehensive due diligence when selecting managers. Data like asset-level benchmarks can play a key role, by enabling investors to compare a manager’s deals across different periods and market environments. That will be a critical tool in assessing allocation decisions.
¹ With most, or all, the underlying deals in these benchmarks fully realized at this point, it can be assumed that returns from those periods are near final.