The vitriolic 2012 presidential campaign painted private equity (PE) with a misleading “buy, strip, and flip” label: wealthy financiers acquire businesses with excessive debt, close factories and cut jobs, and promptly sell for quick gains rather than position companies for long-term growth.
In reality, private equity has an impressive track record of growing businesses and creating jobs in our national, state and local economies – and up and down the food industry supply chain – benefitting Americans in a number of ways. It’s time to review the facts about private equity.
Growing Earnings by Making Companies Better
Private equity has become a meaningful portion of American business. According to PitchBook, Private Equity Groups (PEGs) invested $313 billion of capital into 1,807 deals during 2012, representing 36.9% of total U.S. M&A transaction volume (Bloomberg).
PEGs exist to purchase businesses, finance their growth, build them into stronger businesses, and sell their interests to other investors for a profit. (Note: This article focuses solely on traditional private equity and buyout funds, separate from asset groups like hedge funds or early stage venture capital.) PEGs typically own portfolio companies for three to seven years, at which point the companies are sold to new ownership. Sale valuations are tied to the growth and certainty of future cash flows. Therefore, it is critical for PEGs to build businesses with sustainable competitive advantages, consistent and predictable cashflows, sound operations and viable growth opportunities that subsequent investors will be eager to purchase and capitalize on.
In its “2012 Private Equity Report”, Boston Consulting Group (BCG) reveals that private equity firms have been intensely focused on driving growth by strengthening the operations of their portfolio companies. Through interviews with key personnel at a variety of PEGs, BCG found that these firms have been refining their organizational and deal team structures in a variety of ways to improve their execution on operational improvement initiatives. These efforts have resulted in impressive financial performance. In an analysis of 89 U.S. and European private equity deals closed between 1998 and 2008 , BCG found that more than two-thirds of deals generated annual EBITDA (earnings before interest taxes depreciation and amortization) growth of 20 percent, and nearly half the deals generated annual EBITDA growth of at least 50 percent.
Growing Companies Need More Employees
Private capital-backed businesses have outperformed competitors in terms of both job creation and sales growth. The Association for Corporate Growth (ACG) spearheaded a comprehensive analysis that compared the performance of 23,211 private capital-backed companies to the universe of 52 million U.S. business establishments from 1995 to 2010. The study reveals that private capital-backed companies grew jobs by 64.4% from 1995 to 2010, compared to job growth of 18.3% for all U.S. businesses. Private capital-backed companies grew sales by 112.0% over the same time period – four times the 26.4% sales growth for all U.S. businesses. The BCG and ACG studies convincingly reveal that the industry’s focus on operational improvements have driven top-line and bottom-line growth and have created jobs in our national, regional and local economies.
Superior Returns for Pensions, Trusts
The PE industry’s “customers” or capital providers (called limited partners or “LPs”) are the beneficiaries of this value creation. LPs such as pension funds, endowments, insurance companies, educational institutions and municipal trusts are attracted to private equity because the asset class has consistently outperformed public equity investments. This plays a critical role in portfolio diversification for such institutional investors.
Over the 10- and 20-year periods ending December 31, 2012, the Cambridge Associates U.S. Private Equity Index, which pools data from 1,045 PEGs, generated average net returns of 14.1% and 13.4%, respectively. This compares favorably to 10- and 20-year returns for the S&P 500 of 7.9% and 8.3%, respectively. Furthermore, an analysis performed by Bain & Company for its “Global Private Equity Report 2013” reveals that top quartile U.S. PEGs beat their respective public market benchmarks by 19% since 2003.
According to Preqin, pension funds comprised more than one-fifth of total capital committed to PE from 2009 to 2011. Thus, the superior returns generated by PEGs supports a massive segment of the U.S. population, from young students to teachers to retired factory workers and police officers who depend on retirement benefits to support their families.
Growth for the Long Term
An industry that has grown so rapidly over the past two decades could not have been built on a “buy, strip, and flip” investment strategy, for such a strategy depends on completing deals at cyclical highs in the debt and M&A markets. The private equity industry has grown because so many PEGs have devised compelling strategies for improving the operations and growth prospects of the businesses they own. These strategies result in a win-win: they create jobs and generate attractive returns during all stages of the business cycle.
And, apparently, your food industry peers are taking notice. According to Bloomberg, 2013 has been the North American Food Manufacturing Group’s most active year of mergers and acquisitions (M&A) since 2008. Industry deals in 2013 year to date have totaled $48.7 billion, already above the $42 billion annual Group average since 2008. Packaged foods M&A in North America has been active in 2013, with 21 deals totaling $42.2 billion as of July 3, 2013, compared to $36.7 billion for 40 deals during all of 2012. More importantly, U.S. Food Companies represented by the S&P 500 Packaged Foods Index were trading at a 26% premium to the S&P 500 Index and 22% higher than the five-year average (based on forward price/earnings ratio). Valuations have been boosted by a pickup in M&A activity, and growth in specialty niches like Organic foods, which are expected to grow by more than 12 percent by 2014, are even more lucrative.
Perhaps private equity is a tool that should be considered to drive the growth strategy at your business; it’s certainly not something to be feared.
About the Author: Jim Mahoney is a Partner at Huron Capital Partners. Founded in 1999, Huron is an operationally-focused private equity firm with a long history of growing lower middle-market companies through customized buy-and-build investment strategies. With over $1 billon in committed equity capital, Huron has invested in over 65 companies in North America – including several in the food and beverage sector – that have employed over 7,500 people. For more information, please visit www.huroncapital.com.