Insights & News

Valuation Pulse: Q2 2015

Data Highlights

After a strong first quarter, valuations cooled off a bit on average in 2Q, as volume decreased slightly. Although average valuations were lower, PE buyers were more willing to pay-up for companies that demonstrated certain business characteristics.

GF Data® reported that 199 participating private equity firms completed 103 transactions in the $10–$250 million value range in the first six months of 2015 versus 94 transactions during the same period last year. According to GF Data, the increase in deal volume is likely the result of more firms (both small and large) taking advantage of accommodating market conditions.

For 2Q15, valuation multiples trended lower, averaging 6.5x Trailing Twelve Months (TTM) adjusted EBITDA. However, valuations for the first six months of the year trended higher than last year, due to a strong showing in the 1Q.

Here are the summary transaction data for the previous six quarters:
TABLE 1

All Transactions 1Q 14 2Q 14 3Q 14 4Q 14 1Q 15 2Q 15
# of Deals 41 53 48 63 54 49
TEV/EBITDA 6.4x 6.6x 6.8x 7.0x 7.1x 6.5x
Source: GF Data®

Highlights

  • According to GF Data, the correlation between business characteristics that typically drive value (size, institutional vs. family ownership, and management continuity) has never been stronger. For example, the premium paid for companies with TEV (Total Enterprise Value) of $100 to $250 million versus $10–$25 million was 2.1x, nearing historical highs. Additionally, buyouts of companies with institutional ownership and those with above-average financial characteristics were valued at 7.4x, respectively, versus the overall average of 6.5x. In today’s market, the majority of private equity buyers appear more willing to pay full value for companies with strong business characteristics versus trying to find bargains.
  • During the first half of 2015, equity contributions were lower on average versus 2014 (43% vs. 46.5%). Debt to EBITDA levels remained at 4.0x, which was higher than the historical average of 3.5x. Senior debt averaged 3.0x for 2Q, slightly lower than 1Q. During 2015, senior debt trended higher than historical levels as buyers sought to maximize lower-cost debt capital.
  • Valuations for health care services (7.9x vs. 7.0x), manufacturing (6.8x vs 6.0x), and distribution companies (6.7x vs. 6.3x) were significantly ahead of historical averages during the first half of 2015. Once again, the retail category brought up the rear, coming in at 5.4x versus 6.7x on average historically. In certain sectors, such as healthcare, we are seeing demand exceeding supply.

Pitchbook® M&A Multiples

Although it is difficult to identify a trend with certainty, according to Pitchbook data, deal multiples appear to be cooling off. The average EV/EBITDA multiple for deals closed during the first half of 2015 was 7.3x compared to 10x for both 2014 and 2013. Debt levels have also decreased. Total debt to EBITDA decreased from a high of 6.0x in 2014 to 4.3x in 2015. There are reasons to believe PE multiples will stabilize or possibly ease in the near term. Competition is already strong from strategic buyers, making it less likely that PE firms will stretch their pricing parameters. Also, with interest rate hikes on the horizon, buyers may put the brakes on new investments and focus more on exiting past investments. In fact, one of the biggest trends noted by Pitchbook this quarter is the increase in exits relative to investments. Through the first half of 2015, firms made only 1.7 investments for every exit, the smallest proportion in over a decade. The majority of these exits were made via strategic sales. After two years of 10x multiples, investors may have hit their breaking point on valuations. The following graph presents the annual breakout of EV/EBITDA and total debt/EBITDA multiples since 2006:

graph

Summary

Although it is a little premature to draw conclusions, the transaction data from 2Q2015 indicate that PE valuations may have reached a ceiling. Although activity remains robust, volume has not surged, as some have anticipated. Some of the data suggest that PE firms are more interested in exiting than buying in this environment, as the ratio of exits to investments reached historical highs in 2Q. Volatility in the public markets and concerns regarding future interest rate hikes may have caused buyers to re-think bid strategies, particularly as strategic buyers continue to aggressively participate in the M&A market.

 

PVG Corner

IRS May Limit Discounts on Family Partnership Transfers
Taking advantage of valuation discounts on transfers of family limited partnerships (FLPs) has long been an effective estate planning tool. Families with appreciating assets such as real estate and marketable securities often hold such assets in partnerships or Limited Liability Companies (LLCs). Due to the restrictions on transfer and management rights written into the formation documents of such entities, the fair market value of a non-controlling fractional interest can be significantly less than the pro-rata net asset value. Therefore, transferring or gifting fractional interests can be a tax efficient wealth transfer tool. In recent years, however, there has been speculation that new regulations may be proposed that could limit or prohibit discounts for lack of control and lack of marketability for certain family-owned entities. On May 10, 2015, Cathy Hughes, from the Treasury’s Office of Tax Policy, commented that proposed section 2704 regulations (which deal with the allowability of restrictions in the valuation of FLPs) might be released by mid-September.

Although nothing has been announced to date, many estate attorneys and wealth planners believe that new proposed regulations are imminent. It is likely that the new regulations will limit the applicability of discounts for lack of control and marketability for transfers of certain FLPs. Therefore, if you are considering such a transfer, we recommend consulting with your estate attorney, CPA, and valuation professional prior to making any decisions. A thorough understanding of a family’s assets, goals, and planning objectives is required prior to determining whether a gift or other estate transfer is appropriate.

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