A couple of related commentaries caught my attention today, confirming what I have more directly noticed in the deal market recently: there is a big gap between public stock market valuations and the prices that control-buyers are willing to pay for their business acquisitions. In a tweet from the road, PE Hub editor Dan Primack writes: “Spent day meeting w/ buyout folks here in Chicago. General consensus: Valuations way too high.” In this editorial about the steep decline in leveraged buyout activity, we notice the Thomson Reuters table illustrating the steepness of the decline: from well over $1 trillion in global activity during 2006 and 2007, to something that rounds down roughly to zero since that time.
The implications of such a precipitous fall in private equity activity are numerous, not least of which on the private equity exit environment. While it is true that substantial liquidity continues to sit sidelined in this segment, it is also the case, according to Cambridge Associates, that about 50% of the amounts raised by private equity in the decade just ended have in fact been invested. These deals will be looking for exits soon – or already have been – and one of the favored exit mechanisms, especially in the absence of a reliable IPO market, has been the sale of positions to other buyout funds. But not if these are no longer buyers.
The deal backlog that the situation highlights, not only in terms of funds trading deals among themselves, but in terms of private market activity in general, is a side-effect of public capital markets that seem to become increasingly inefficient. A market dominated by machine trading – at some 70% of daily volume – and institutions with access to federal capital at no cost, is prone to distort the true value of equity. Distorted or not, these public benchmarks serve as valuation parameters – especially for sellers – in M&A and other private or going-private transactions.
And this is where problems arise. If private buyers – without access to artificially cheapened capital, without the daily liquidity that would allow the offloading of positions in an opportunistic price spike, and with a perspective on economic prospects that is necessarily based on long term fundamentals – are unwilling to meet potentially anomalistic valuation levels set by “the market,” then the transacting parties are at an impasse. Public shareholders will not be able to justify selling below market, or at anything less than a takeover premium; and in the case of private sellers, the valuation comparables used to determine a fair price serve to inflate expectations. The result: sellers who don’t need to sell don’t, opting to wait for “improved conditions,” and buyers who can’t buy at their price also don’t, as evidenced by the private equity charts previously referenced.
In recent economic data, we have seen that strategic – as opposed to financial – buyers are now sitting on record levels of cash and equivalents. Taken in combination – financial and strategic deal-doers opting to do less with more – may be both a statement on the diverging economic outlook between the public and private markets, and one about a market inefficiency that is magnified in the current climate.
