RSM McGladrey Survey shows private equity execs confident about portfolio company performance
Most expect a return to dealmaking
CHICAGO – (May 19th, 2010) – According to results of an annual survey conducted by RSM McGladrey and McGladrey Capital Markets, senior executives from some of the nation’s top private equity (PE) firms say they have essentially completed aggressive cost cutting within their portfolio companies and are confident about those businesses’ growth and profitability. Many plan to increase hiring during the coming year, and most expect to turn much of their attention back to dealmaking.
This year’s survey polled 148 executives from buyout, mezzanine and venture capital firms during the first quarter of the year.
In a marked contrast from the previous year’s survey, PE firms have turned from an emphasis on cutting costs to a focus on growth – in some cases including staff additions. Almost one in three (31 percent) forecast increases in staffing levels, compared to less than one in 10 respondents (8 percent) who expect staffing levels to shrink. PE firms have reduced their involvement in day-to-day operations and areas such as human resources, information technology and purchasing; they now are concentrating on “big picture” issues such as strategy, lender relationships, finance and accounting.
“Last year, survey respondents told us they had largely suspended dealmaking and fundraising to focus on portfolio company performance – reducing employee headcounts, freezing salaries, improving business processes and reducing capital spending,” said Bob Jensen, managing director with RSM McGladrey and a leader in the firm’s private equity practice. “But now they’ve made the difficult cuts and can focus on growth – whether organic or through acquisitions. We’re seeing PE firms returning to dealmaking, especially in the lower middle market.”
This year more than half of survey respondents (56 percent) expect to complete two to five add-on acquisitions in 2010, and almost half (43 percent) plan on completing at least two or three platform acquisitions. Almost one in 10 (9 percent) forecast adding six or more platform companies to their portfolios.
While deal activity is expected to increase, raising capital and acquiring acquisition debt financing continue to be significant impediments to completing transactions.
“Raising equity capital is still challenging, largely because private equity, as an asset class, has suffered declining investment returns,” said Hector J. Cuellar, president of McGladrey Capital Markets. “However, pension funds and other LPs are continuing to invest in private equity, with lower middle-market funds being the primary beneficiaries.”
“At the same time, many funds still have a fair amount of dry powder they’ve yet to deploy, and the debt financing picture is steadily improving,” Cuellar continued. “I wouldn’t say debt is easy to obtain, but it clearly is becoming more available. Further, many lenders are permitting significantly greater leverage on some transactions.”
Other dealmaking challenges cited by survey respondents included sellers’ unrealistic valuation expectations (identified by 29 percent of the respondents) and lack of attractive acquisition candidates (26 percent). Cuellar is already seeing conditions improve and expects that to continue for the foreseeable future.
“As debt financing becomes more available, private equity buyers will be able to offer higher multiples, which in turn will attract more high quality sellers to the market,” he said.
A significant concern among survey respondents is the relationships between PE firms and their investors. For example, more than three out of four respondents (76 percent) are at least somewhat concerned about the implementation of claw back provisions; almost one in three (32 percent) are very concerned. Moreover, 67 percent of the sample expressed concerns about changes in management fees; 25 percent said they were “very concerned.”
In addition, more than nine-in-ten respondents (91 percent) expressed at least some agreement with the statement “we are experiencing investor partner defaults and withdrawals,” with 71 percent indicating they “strongly agree” with the statement.
“When PE funds were delivering double digit returns, investors were less concerned about management fees and tended to give general partners the benefit of the doubt. But when portfolio company performance declined and investment returns suffered, LPs became noticeably less tolerant,” said Jensen. “Most institutions suffered hits in all their asset classes and are now under pressure to rebalance their portfolios. Some are even facing concerns about solvency. But private equity will maintain a position in most institutional portfolios. ”
Obtain a copy of the survey, or contact Sarah Larkin at (612) 376-9225 or Sarah.Larkin@mcgladrey.com. Go to the 2010 Managing Portfolio Investments Survey page for additional information and industry-related audiocasts.
About RSM McGladrey
About McGladrey Capital Markets
McGladrey Capital Markets is affiliated with RSM McGladrey Inc., a professional services firm providing accounting, tax and business consulting. Both firms are indirect subsidiaries of H&R Block Inc. (NYSE: HRB), the world’s preeminent tax services provider. McGladrey Capital Markets’ international headquarters are located in Costa Mesa, Calif. The firm is a member of FINRA.
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