With the world seemingly on the precipice of an acute supply shock, you probably want some financial data to bring you comfort as your precious stonks head south. Tough luck:
Yep, that’s the ratio of debt-to-ebitda across private equity deals in the past 17 years from the latest version of Bain & Company’s annual report on the sector.
The 96-page report covers quite a lot of what you might already think about the private equity business. Namely, multiples are elevated, leverage is egregious, there’s copious “dry powder” on the sidelines and it’s hard to see where its historically stonking returns will come from after a near-decade run in earnings growth and multiple expansion.
Well mainly multiple expansion, because as it turns out, private equity is not very good at hitting its profit targets:
Much has been made, in this paper and others, of the report’s finding that the S&P 500 has outperformed private equity in the past decade. It’s a sobering stat, particularly considering the leverage (and other tricks) used to juice private equity returns, and the institutional “all-in” on the sector.
But these two charts are perhaps the most telling. One of the frequent justifications for private equity is that the model encourages operational excellence. The general partners hire a top-dollar management team, carefully set the incentives, and then watch a business flourish outside of the highly-scrutinised world of public markets.
And that is true looking at the above: revenue grows, and margins expand. But what’s more true is that if you paid $1.00 for a company in say, 2010, and nothing changed about the business in the time while you were in charge, it would be worth $1.60 when it was sold. A glorious 60 per cent return for doing sweet nothing.
Despite the small sample size, the chart does reveal how beholden private equity is to the public markets. Without a listed equivalent to roughly set the correct profit multiple for a company, it would be much harder to justify a higher multiple exit. Particularly as private equity deals aren’t a beacon of transparency.
Thoughts and comments on the report welcome below, but we recommend glazing over between pages 43 and 54. It’s all about ESG.