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Private Equity Creates Value In Europe « Back
Selina Harrison, July 2012
 
In recent years, legislation such as the Dodd-Frank Act has aimed to curtail banks’ involvement with the private equity industry. Meanwhile, criticism of the PE industry in the run up to the US presidential election has done little to improve its reputation. Even so, a recent study by Ernst & Young (E&Y) proves that, contrary to public opinion, PE generates the majority of returns for its investors through creating lasting value rather than leverage. Further, the study proves that PE has played a positive role in European society, creating stronger, more competitive companies and providing much-needed capital to help Europe’s companies expand at a time when banks are de-leveraging and other sources of financing are constrained.

In association with the European Private Equity and Venture Capital Association, E&Y have been studying and producing reports on how European-based businesses owned by PE have created value since 2005. E&Y tracked companies with an enterprise value (EV) of more than €150m at the time of PE investment; over the last seven years, 473 companies met the criteria for the study.

Data from the study shows that in Europe, exit volumes are on the increase. Up from 60 in 2010, in 2011 there were 83 exits of PE-owned businesses. Despite the macroeconomic uncertainty that played out in the second half of the year, this marked the highest exit volume since 2007, before the financial crisis erupted. After sitting on the sidelines for a number of years, corporates have strengthened their balance sheets and appear more willing to use their cash. Indeed, sales to trade buyers accounted for 39 percent of 2011 exits, their strongest performance since 2005 when they made up 41 percent of buyers from PE portfolios. However, highlighting the turbulence within the financial markets, only five firms managed to exit their company via an initial public offering in 2011, just half the number of listings made in 2010.

Data from the study also demonstrates that during the past seven years PE investment has added value to deals of all sizes. PE firms that invested in European companies with an EV in excess of €1bn witnessed a public market return of 31 percent on their total return, with the effect of additional leverage representing a similar amount, and PE value creation accounting for 38 percent of the total. For smaller deals the return was even greater. Deals with an EV between €150m and €500m witnessed returns of almost two-thirds due to PE strategic and operational improvements.

Barring the Nordics, where the absolute return equals the average across all countries, data from the study shows that during the past seven years PE’s value creation model has worked across Europe’s different markets, generating an investment return at least 2.5 times the comparable public company return. PE investment has also driven productivity gains and heightened employment. During the same period, PE investment improved productivity 6.9 percent on average per annum across all European markets. It has therefore created more valuable, fitter European businesses while also increasing employee numbers – employment grew by an average of 2.2 percent per annum under PE ownership.

Sector wise, E&Y purports that during the last seven years, companies in business services, retail and healthcare have all delivered above-average returns and above-average portfolio growth under PE ownership. E&Y note that while business services deals are typically smaller than average, they have grown as strongly and delivered above-average returns. Hoping to capitalise on the needs of an aging population in Europe, PE portfolio growth has been highest in the healthcare sector on continued fiscal growth. Meanwhile, PE firms have also pocketed significant gains from the retail sector, albeit with growth driven mainly by large transactions completed before the credit crunch. The report also notes that while the incidence of creditor exits in this sector is low – one of the contributing factors to the sector’s above-average performance – exit activity is below average.

This study demonstrates that much of the criticism levelled at the industry is misplaced and, despite the challenging financial climate, during 2010 and 2011 PE firms in Europe weathered the storm and continued to provide returns to investors by driving fundamental changes to the businesses they back, improving productivity and creating sustainable value.

Even so, the report advises that for PE firms to continue to generate attractive returns, they must seek out companies with the most potential and then work actively with these companies to help their investments reach their peak. Detailed research and origination have always been key elements of PE’s success, but the real skill comes from choosing the right niches and individual investment opportunities, then making them work. Firms that can evolve by learning from the lessons of the past, building on experience and identifying future opportunities, are the most likely to succeed.

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