Smaller Deals are Becoming Increasingly Important in the world of Private Equity

In the world of private equity, the winds of change are blowing, and the buyout barons are adjusting their strategies accordingly. The era of mega-buyouts might be waning, but staying engaged with smaller deals is proving to be a smart move in this evolving landscape. With capital hoards that need to be spent, private equity firms are finding value in relative minnows, reshaping the industry's dynamics.

Recent data from Dealogic paints a revealing picture. Private equity companies made approximately $300 billion in acquisitions through August 15, a stark contrast to the frenetic pace of last year. This figure is also just 6% higher than the pandemic-induced low of 2020. However, the deals in the range of $1 billion to $5 billion are the ones keeping the momentum alive, running nearly parallel to 2022 levels.

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Some elements of these deals still resemble the traditional playbook. Take, for instance, the acquisition of Simon & Schuster by KKR for $1.6 billion or STG's $1.4 billion purchase of Avid Technology. Yet the financing landscape is evolving. STG, for example, secured almost 40% of its financing from private lenders, showcasing a shift in funding sources. Clayton, Dubilier & Rice also took a unique approach, using five banks to finance its $2.3 billion acquisition of Veritiv.

However, there are challenges to contend with, particularly in the face of rising interest rates. Lenders are becoming more cautious, demanding higher operating profits to cover interest payments, which necessitates using less debt and subsequently reduces potential profits. For instance, GTCR Capital's $17.5 billion purchase of 55% of Worldpay required a significant equity injection of 15% of its assets, a choice that implies a belief that interest rates won't fall anytime soon.

On the flip side, takeover targets, especially smaller companies, are becoming less amenable to valuation cuts. This is illustrated by the slower rebound of the mid-cap S&P SmallCap 600 Index compared to the S&P 500 Index this year. Negotiations can be protracted as buyers and sellers wrestle over valuations, sometimes leading to deals stalling until one side concedes.

Yet the significance of big buyouts remains palpable in the private equity sector. The industry is sitting on a staggering $1.1 trillion in dry powder as of 2022, according to Bain Consulting. Interestingly, approximately 90% of funds raised earlier this year were allocated to the middle market, indicating a shift away from the mega-deals of the past. Flagship funds are also shrinking, underscoring the changing dynamics within the industry.

This shift may signal a new era for private equity, where the ability to adapt and thrive in a changing environment becomes the key to success.