Equity firms shift more investments to health care industry
Middle-market private equity firms are shifting some of their investment focus away from the manufacturing and telecommunications sectors to the health care and service industries, according to a new survey by Robert W. Baird & Co.
Baird released its first annual middle-market private equity firm survey earlier this month.
The Milwaukee-based company’s Investment Banking Department contacted 390 firms for the survey and received 190 responses.
"Based on our review of the data, it appears that private equity will be greater in 2003 than in 2002," Baird said of the survey in its May "Merger Monthly" report compiled by Steven Bernard, director of merger and acquisition research, and Marisa Thompson, M&A research analyst.
Highlights of the survey included:
— Despite expectations that the economy and financing environment will not improve significantly in the next 6-12 months, private equity firms plan to increase their buy-side and sell-side activities in the next 12 months.
— Many firms have altered their investment focus, moving away from capital-intensive sectors such as technology/telecom and manufacturing and focusing more on health care and service-related industries. Many firms also indicated an increased focus on public companies.
— Private equity firms have a significant amount of capital available to invest. Results from the survey indicate that the average middle-market firm has invested just 38% of its current fund.
— Baird calculated the average investment age of the portfolio companies to be just over three years, indicating an increased backlog of pending exits.
— The average number of investments that middle-market firms expect to make over the next 12 months is more than 50% higher than the average number of investments made in 2002.
— Nearly one-quarter of the responses indicated that they have lowered their investment return requirements.
— Most firms indicated a significant number of investment exits will occur over the next 12 to 36 months, with 75% of these exits expected to be through an M&A transaction.
"The majority of the firms focus their investments in traditional, old-economy industries. The industrial sector was the industry which had the most investment interest, followed closely by business services, distribution and consumer," the report stated.
However, that "old-economy" focus is changing, according to the survey.
"Almost 25% of the respondents indicated that they had changed their industry focus over the past 12 months. Although we received a variety of responses, the two major themes that dominated the list were: (1) an increased focus on service industries; and (2) less focus on manufacturing, as well as telecom and software. The most often cited industries for increased focus were business and consumer services and healthcare/medical devices. Also listed in the responses was a greater focus on larger companies, as well as public companies," the report stated.
Some other findings of the survey included: more than 90% of the firms responding indicated they would consider a leveraged buyout offer (LBO); 86% would consider recapitalization; and 78% would consider a going-private transaction.
"We expect that private equity firms will be active buyers in 2003, given the amount of money that remains uninvested," the report stated. "The firms in our survey have an average of just 38% of their current fund invested."
Approximately two-thirds of the respondents’ available funds are expected to be used for new platform acquisitions, with the balance to be used for add-on acquisitions, the survey indicated.
"The current market environment has led many firms to hold off exiting their investments in 2002, hoping for an improvement in both valuation multiples and the financial performance of their portfolio companies," the report stated. "This has led to a growing backlog of portfolio companies that must eventually come to market. We calculated the median age of a portfolio to be about three years, indicating that many portfolios are becoming mature. As the holding period of the companies in the portfolio increases, private equity firms will be looking to realize portfolio returns, especially as they plan future fund raising."
The pent-up demand would be welcome news for the economy.
"Last month, we asked, ‘Can it get any worse?’ and the answer seems to be, ‘Yes it can,’" the report stated. "Distracted by the events in Iraq and the economy, M&A activity fell sharply in the month of April."
The total value of worldwide transactions for the month of April $76.3 billion, down 19.1% for the same period a year earlier, according to Thomson Financial. The total number of worldwide transactions for the month was 1,407, a 23.6% decline from a year ago.
Monthly global activity has not shown a positive year-over-year comparison since 2001.
However, one recent report suggests that the market may have finally bottomed out. The US default rate for corporate bonds fell 75% in the first quarter to $6.5 billion from 26 issuers, compared with $26.3 billion from 55 issuers in the same period a year ago, according to Fitch Inc.
May 30, 2003 Small Business Times, Milwaukee