4Q 2012 Private Equity Company Inventory Report Sponsored by:
www.newstarfin.com
Introduction In the last few quarters, an overwhelming number of the inquiries coming in to the Research Team have centered on two metrics: the company inventory and the capital overhang. It s no wonder why investors, analysts, and media sources are so enamored with these two data points. The years leading up to the financial crisis saw record-breaking fundraising and deal-making efforts, resulting in a glut of capital and portfolio companies that have become leading indicators for the health of the PE industry in recent years. When we last reported on the company inventory, the total number of U.S.-based, PE-backed portfolio companies sat at 6,238 through 1Q 2012. Our latest calculation shows that the company inventory now sits at 6,538, as of November 30, 2012. While the inventory continues to grow, it s important to note that the rate of expansion has decreased considerably in recent quarters. As the chart on page four shows, the ratio of new buyout deals to exits of PE-owned companies has dropped from the 5x to 6x range during the boom years to 2.2x for the first two months of 4Q 2012. The makeup of the company inventory has been changing as well. In recent years, the proportion of companies acquired for $100 million to $500 million has grown considerably. There have also been relatively fewer Consumer Products and Services (B2C) companies added to the inventory in recent years as the percentage of Energy, Financial Services, and Healthcare businesses has expanded. As we enter a new year, it appears that the number of PE-backed companies has reached an inflection point. The company inventory s rate of expansion has slowed drastically in recent years, and we expect this trend to continue in 2013 as PE firms concentrate on realizing their existing investments. Increasing proportions of add-on deals and secondary buyouts are inhibiting growth in the company inventory as well, as both types of transactions have no net effect on the company inventory. In addition to the company inventory, the amount of dry powder currently available to firms has become one of the most talked about data points in the PE industry. For those interested in the capital overhang, the number sat at $432 billion when we reported it in 1Q 2012. Look for an updated capital overhang number in the next edition of our Fundraising and Capital Overhang Report, scheduled to publish in January. NewStar Financial, Inc. is a specialized commercial finance company focused on meeting the complex financing needs of companies and private equity groups in the middle market. NewStar specializes in providing a range of senior secured debt financing options to mid-sized companies to fund working capital, growth strategies, acquisitions and recapitalizations, as well as equipment purchases. The company originates loans and leases directly through teams of experienced, senior bankers and marketing officers organized around key industry and market segments. We generally target loan sizes ranging from $10 to $150 million and lease transactions from $0.5 to $3 million, but we also have the ability to do both smaller and larger deals to meet customer requirements. NewStar was founded in 2004 by a team of experienced banking executives with over 160 years of combined corporate finance experience. We have completed more than 375 deals since then providing in excess of $4.6 billion of senior debt to companies backed by more than 200 private equity investment firms. We understand the time constraints and deal dynamics of acquisitions. Our business and related credit processes are designed to enable our bankers to provide you quick market reads and feedback on transactions. Our team approach and flat organizational structure also allows us to make quick decisions and deliver on what we promise. The combination of NewStar s banking and capital market expertise, industry relationships, substantial capital base and efficient credit process make it the ideal fit for mid-sized companies and private equity groups. 1
Overview 8,000 Inventory of Private Equity-Backed Companies 7,000 6,000 5,000 4,000 3,000 2,283 2,978 3,800 4,703 5,342 5,637 6,020 6,344 6,538 Year of Investment 2009-2012* 2005-2008 2,000 2000-2004 1,000-2004 2005 2006 2007 2008 2009 2010 2011 2012* As of Year Source: The company inventory continues to grow, but it s important to note that its expansion has been waning in recent quarters. In the run-up to the financial crisis, the company inventory was growing between 25% and 40% annually, but that trend quickly subsided in 2008 as investment dwindled. The company inventory grew just 6% in 2008 and has continued to expand at a reduced pace, only ticking up 3% from 2011 through the first 11 months of 2012. One of the most notable characteristics of the current company inventory is the fact that nearly half (47%) of the companies were acquired from 2005 to 2008, during the height of the financial boom. In fact, 2006, 2007, and 2008 have three of the four highest totals of currently PEbacked companies. Despite being five years removed from the record-breaking investment numbers witnessed in 2007, there remain more than 1,000 PE-backed companies that were purchased in 2007 more than any other year. Considering that many PE professionals see three to five years as the standard holding period for a portfolio company, this is a major development for the industry. To that end, the median holding period for portfolio companies has risen 53% since 2007, from 3.49 years to 5.33 years in 1H 2012. With the company inventory continuing to grow, albeit at a slower pace, the holding period should only Inventory by Investment Year 1,000 750 500 250 0 00 01 02 03 04 05 06 07 08 09 10 11 12* Source: increase as the median age of a PE-backed company is now 4.9 years. Prolonged holding periods are part of an ongoing sea change in private equity, as the emphasis continues to shift from financial engineering and multiple arbitrage to topline revenue growth and operational improvements. 2
Inventory Breakdown 100% 80% 60% 40% 20% Inventory by Investment Size 9% 28% 3% 5% 25% 30% >$2.5B $1B-$2.5B $500M-$1B $100M-$500M $25M-$100M <$25M 0% 2000-2004 2005-2008 2009-2012* Source: As to be expected, the majority of currently PE-backed companies are concentrated at the lower end of the deal spectrum; more than half (55%) were originally acquired by their PE sponsors for $100 million or less, and 28% fall in the $100 million to $500 million size bracket. However, it is worth noting that there was a significant influx of mega-deals in the mid-2000s, and larger acquisitions have continued to represent a considerable portion of the inventory in recent years. These large businesses are likely starting to wear out their welcome in PE portfolios, as there are still 107 companies that were acquired for more than $1 billion in the 2005 to 2008 timeframe alone. Big investments typically require a well-endowed corporate acquirer or an IPO to achieve an exit, making them inherently more difficult than smaller deals. And, the longer it takes to sell these companies, the lower the IRR will be on a significant amount of capital. 100% 80% 60% 40% 20% 0% 2000-2004 2005-2008 2009-2012* Inventory by Industry 6% 10% 9% 37% 5% 5% 28% B2B B2C Energy Financial Services Healthcare IT Materials & Resources Source: Investment in B2B and B2C businesses has been a hallmark of the PE industry, so it was unsurprising to find that these two industries combine to account for 65% of the current company inventory. Looking at the breakdown by investment period, however, it appears that the B2C industry may be falling out of favor with PE investors. The industry represents 37% of the currently held portfolio companies acquired from 2000 to 2004. But in the postcrisis era, from 2009 to the present, B2C businesses comprise just 25% of the inventory. Three industries have emerged to fill the void left by B2C: Energy, Financial Services, and Healthcare. While still accounting for relatively small portions of the overall inventory, each one of these industries has seen its share of the inventory at least double in the 2009 to 2012 investment period compared to the 2000 to 2004 timeframe. 3
Investment Trends Taking a look at investment patterns in the PE industry can provide context and help explain some of the recent developments in the company inventory, as well as offer a glimpse into what is likely in store in coming quarters. As can easily be deduced, the incredible escalation in the company inventory over the last decade was the result of a wide imbalance between the number of new buyouts and the number of exits. In the run-up to the financial crisis, the ratio of buyouts to exits was 5x or more in virtually every quarter. Beginning in 2010, however, we observe a convergence between the number of new buyout deals and exits, with the ratio rapidly dropping to approximately 3x throughout 2010 and 2011. The difference between the two statistics has closed even more in 2012 and sits at 2.2x through the first two months of 4Q. If this trend continues and we believe it will, given the current PE landscape it will only be a matter of time until the company inventory plateaus fully. Another significant recent development has been the increasing prevalence of secondary buyouts, as PE firms look among themselves to source new deals and achieve exits. The chart to the right shows the surge of secondary buyouts as a percentage of total buyouts, ballooning from a nadir of 2% in 1Q 2009 to 24% so far in 4Q 2012. It s worth noting that secondary buyouts are a zero-sum game when it comes to the company inventory, as the company will still have a PEbacker after the transaction. Due to the negotiations that inevitably occur between PE firms on opposite ends of the table, secondary buyouts are unlikely to generate the types of returns that could be 600 500 400 300 200 100 0 30% 25% 20% 15% 10% 5% 0% 5.5x 5.2x New Buyouts v. Exits from Buyouts 4.7x 4.5x 6.0x 4.5x 5.4x 5.2x 4.2x Secondary Buyouts as % of All Buyouts achieved via a corporate acquisition or IPO. However, as the lengthening holding period indicates, realizing an exit in the current environment is proving more difficult than most anticipated when making their original 3.7x 3.3x 3.x 3.0x 3.2x 2.9x 2.7x 2.7x 2.5x 2.3x 2.2x 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q* 2008 2009 2010 2011 2012 Ratio of Buyouts to Exits Buyouts Exits 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q* 2008 2009 2010 2011 2012 7x 6x 5x 4x 3x 2x 1x Source: Source: investment. For PE firms that have reached or are nearing the end of their fund mandate, simply getting a deal done may be the top priority, even if it means accepting a slightly lower return than initially anticipated. 4
Inventory Breakdown by State 109 11 5 58 761 37 70 5 15 Methodology 130 8 11 153 9 13 30 643 64 Company Inventory: This report includes all U.S.-based companies that are currently under majority ownership by a private equity firm as a result of a buyout transaction. Definition of Buyout: With the exception of add-ons, all types of buyout transactions are considered, including LBOs, MBOs, public-to-private buyouts, secondary buyouts, and corporate divestitures. Definition of Exit: For this report, exits are defined as the sale or IPO of a company that was acquired via a buyout. 65 156 29 118 19 53 154 331 18 Private Equity 124 146 62 191 60 264 264 382 15 77 168 175 302 Source: 417 9 115 17 44 207 137 221 Key 11 >300 200-300 100-200 50-100 <50 Not Shown 22 Washington D.C. 22 Puerto Rico 8 Other U.S. Territories 2 Guam 1 Did you know? You can search for and view detailed profiles of all 6,538 companies in the inventory using the Platform. Watch the video walkthrough to learn how. 5
90,296 23,257 57,153 8,526 6,621 17,129 Deals Investors Companies Service Providers Limited Partners Funds Want the whole pie? tracks more Private Equity and Venture Capital data than anyone. * All data sourced from the Platform as of 12/11/2012 1-877-636-3496 sales@pitchbook.com Private Deal Comps Targeted Business Development Sourcing New Deals Targeted Buyers Lists Benchmarking Funds & IRR Public Company Fundamentals Corporate Headquarters 1201 Alaskan Way, Pier 56 - Suite 200 Seattle, WA 98101