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, benefitting Americans in a number of ways. It’s time to review the facts about private equity and see how it can help to continue the positive momentum in the coatings industry.
Growing Earnings by Making Companies Better
Private equity has become a meaningful portion of American business. According to PitchBook, PE firms invested $313 billion of capital into 1,807 deals during 2012, representing 36.9 percent of total U.S. M&A transaction volume (Bloomberg).
PE firms exist to purchase businesses, build them into stronger businesses and sell them 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.) Funds 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 PE funds to build businesses with sustainable competitive advantages, sound operations and viable growth opportunities that eventual acquirers will be eager to purchase and capitalize on. As the economy continues to improve in the United States and across the globe, especially in the housing market, the demand for paint and coatings products should rise and open the door for successful PE initiatives.
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 from private equity firms, BCG found that 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 2008,1 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
According to the American Coatings Association, the U.S. paint and coatings industry employed 256,800 workers in 2012 and had nearly 44,700 establishments. Private capital-backed businesses have outperformed competitors in terms of job creation and sales growth, making it an excellent option for companies to continue when exploring expansion opportunities. 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 percent from 1995 to 2010, compared to job growth of 18.3 percent for all U.S. businesses. Private capital-backed companies grew sales by 112 percent over the same time period – four times the sales growth for all U.S. businesses of 26.4 percent. The BCG and ACG studies convincingly reveal that the industry’s focus on operational improvements have driven top- 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 and trusts, are attracted to private equity because the asset class has consistently outperformed public equity investments, while PE returns are weakly correlated with public market returns. This plays a critical role in portfolio diversification.
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 private equity funds, generated average net2 returns of 14.1 percent and 13.4 percent, respectively. This bests 10- and 20-year returns for the S&P 500 of 7.9 percent and 8.3 percent, respectively. Furthermore, an analysis performed by Bain & Company for its “Global Private Equity Report 2013” reveals that top quartile U.S. funds beat their respective public market benchmarks by 19 percent 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 private equity support 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 firms 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. Not all investment strategies work, but the ones that do ensure that private equity will continue to have a positive impact on the economy.
The data and statistics cited in this article are from the sources noted and have not been calculated or verified by the author. For more information, visit www.huroncapital.com.
1Includes deals with a minimum enterprise value of $670M.
2Net of fees and expenses.