Engaging for Growth

Over the last few years, the private equity industry has been shifting away from leverage and toward operational improvement as the main way to create value. That’s meant private equity firms have had to experiment with new operating models.

There are signs that increased engagement on the part of private equity firms pays dividends in terms of value created. BCG studied the operational performance of 89 US and European private equity deals that closed between 1998 and 2008, and exited between 2005 and 2011. These deals had a minimum enterprise value of €500 million at exit.

Roughly 70% of these deals generated an absolute increase in annual EBITDA of at least 20%. Nearly half saw growth of 50% or more. The analysis showed that the deals with the highest growth were also those for which private equity firms paid the highest multiples. This suggests that the firms had a clear idea before the deal of how they would improve the target company’s EBITDA.

The main reason for this shift in focus to operational value is accelerating market change in response to three trends.

Lower levels of debt and higher acquisition premiums mean that private equity firms will be unable to count on leverage or multiple expansion as major sources of value in the immediate future. Improvements in fundamental value, as reflected in growth in EBITDA, are the only sure source of value creation.

What’s more, the wave of cost cutting at companies in response to the recession has led to fewer opportunities in which fundamental value can be generated rapidly by cutting costs. Private equity firms will increasingly have to generate EBITDA growth by growing existing portfolio businesses.

Principal Investors and Private Equity