US middle-market PE activity slumps

January 2017 | DEALFRONT | PRIVATE EQUITY & VENTURE CAPITAL

Financier Worldwide Magazine

2016 has been a difficult year for middle market PE activity. Though compared to historical norms it has been relatively strong, there is no disguising the fact that the number of transactions and the total value of deals recorded in the first three quarters of 2016 was down on 2015, according to Pitchbook’s US PE Middle Market Report 3Q 2016. Exits, too, have declined over the same period

Though deal activity in the $10bn and above range has boosted overall PE activity in the US, the middle market has continued to slow. Overall, the PE industry saw 1330 transactions worth a combined $265bn through the first three quarters of the year, a 9.7 percent year on year decline in value and 16 percent fall in the number of deals compared with 2015. A lack of headline grabbing deals and a relative dearth of deals worth upwards of $10bn has made the decline seem more severe.

In the middle market, median deal sizes up to the end of the third quarter were $128.6m, down from $133m in 2015 and $150m in 2014. PE funding has poured into the middle market in recent years, with the lower and middle strata benefitting enormously.

Pitchbook attributed the decline in deal sizes, in part, to add-on transactions. Indeed, add-on deals now account for around 64 percent of all US buyout transactions, including those above the upper middle market.

For PE firms targeting the lower middle market range (between $25m and $100m) the sheer number of mid-market sized businesses has led to a crowded marketplace and high prices. Though there will be ample opportunities for PE funds to acquire companies in the middle market space, they will have to contend with a number of key issues. Primarily, the cost and quality of prospective targets may continue to stymie deal activity in 2017.

PE backed exits in the US middle market also declined over the first three quarters of 2016, with 593 deals totalling a little under $51.5bn. This represented a 20 percent and 33 percent year-on-year decline for 2014 and 2015 respectively. Secondary buyouts made up 52 percent of exits during Q3 2016. Corporate acquisitions accounted for 44 percent, and IPOs just 4 percent. For the first time in more than 10 years, the second and third quarters of 2016 saw more secondary buyouts than corporate acquisitions in two consecutive quarters. This trend seems likely to continue, with the sellers increasingly unwilling to pursue IPOs.

Due to more secondary activity within the market, there is a concern that some LPs may incur additional transactional fees if they are involved on both sides of a deal. However, this cost may be offset if a portfolio company, as a result of a secondary buyout, is being operated by more effective management.

Fundraising in the mid-market space, despite the emergence of a number of ‘megafunds’, remained strong in the third quarter of 2016. Through the first three quarters of 2016, the middle market saw $80bn worth of funding closed across 121 vehicles. Though this figure represents around 9 percent less committed capital compared with 2015, the total was reached via the same number of funds as 2015, suggesting that the market has remained relatively strong.

Interestingly, it appears that the 2016 presidential election had little to no bearing on activity in the middle market. The decline seems to have been underway well before the election began to make political and financial waves. According to Pitchbook, the drop in activity was derived from “market fundamentals that were in play long before the political environment became… uncertain”. In addition the time frames required for PE transactions mean that firms will have factored the election result into their business plans.

Richard Summerfield