The annual Mergers, Acquisitions & Buyouts Conference is the showpiece of the Vlerick Centre for Mergers, Acquisitions and Buyouts and a key event for everyone working in the sector. The tenth edition was another resounding success. Professors Mathieu Luypaert and Miguel Meuleman extracted ten important insights from over a decade of research. We discuss them here, for those who were unable to attend. In the first part of our report, we talked about the five things we learned about mergers and acquisitions. Now, in this second part, we review the five things we have learned about buyouts financed by private equity (PE).
Like mergers and acquisitions, PE players have a bad reputation. In the past, they have often been portrayed as sharks or raiders who buy into a company, restructure it and lay off employees to make a quick profit. In short, they supposedly create value for their shareholders at the expense of other stakeholders in the portfolio companies. Vlerick researchers investigated whether that reputation was deserved by means of a meta-analysis of more than 60 studies around the world, including nearly 500,000 portfolio companies, in the period 1980–2020. They found that there was a significant positive impact on both revenue growth and the efficiency of the portfolio companies following a buyout. So value is indeed created. What is equally important is that this occurs without any significant negative effect on employment; in some cases the effect is actually positive.
Before 2010, the focus of PE companies was on improving efficiency. It has since shifted to a focus on growth. The meta-research above made this clear. Moreover, an analysis of French leveraged buyouts has shown that value creation through growth mainly occurs in transactions with non-listed players. This is because PE firms help their portfolio companies to obtain private financing and bank loans, so that these companies can grow. An American study of consumer goods manufacturers who sold their products through supermarkets and drugstores has also shown that manufacturers funded by PE experienced an average 50% increase in revenue five years after a buyout, compared to similar manufacturers with no PE funding. This growth in revenue is only partially explained by price increases; above all, it is due to a greater increase in the number of products offered, innovation, geographical expansion and advertising expenditure. Incidentally, the study only found this growth among non-listed manufacturers. In general, buy-and-build strategies drive particularly strong growth. An extensive study of buyouts and additional acquisitions in 86 countries over a 16-year period shows that experienced PE companies with a good reputation were most likely to apply these strategies to larger portfolio companies with experience in mergers and acquisitions. We also observe more buy-and-build activity and faster settlement of acquisitions among experienced, reputable PE companies.
It is a good idea to be familiar with the sector in which you want to make an acquisition. That applies to buyouts funded by PE as much as to anything else: portfolio companies of PE firms with sector specialisation tend to be more profitable after a buyout, as shown, for example, by a study of 244 companies in the UK, half with PE funding and half without it. Specialised PE firms are familiar with the competitive landscape and can better assess the strengths and weaknesses of potential portfolio companies, so they choose better investments that they also better monitor and advise after the buyout. That picture is confirmed by two American studies1 that investigated the impact of sector specialisation. For example, restaurants in the portfolio of PE firms with experience in the restaurant industry score better in FDA inspections. Buyouts of hotel chains financed by PE firms specialising in the hotel industry report higher operating margins and net cash flows over the entire financing period and deliver larger capital gains upon exit. Incidentally, though, the ratings of these hotels on review platforms like TripAdvisor tend to drop. So customer service seems to suffer from the buyouts.
The financial implications of PE participations have been thoroughly studied, and more research into the social impact is gradually starting to be done. This is relevant because ESG criteria are becoming more important, but also because more and more PE funds are investing in sectors with a social purpose, such as healthcare, older people's care, education and media. Given the reputation of PE firms, what can we say about the trade-off between financial and non-financial value? When it comes to the consequences for personnel, various studies have looked into employment and pay after a PE buyout. Studies from the US reveal major differences depending on macroeconomic conditions, the credit climate, the PE group and the type of buyout. The meta-analysis cited above identifies differences between countries with or without labour legislation that provides strong protection. For the time being, there are no indications that employees’ health is adversely affected, and as far as safety at work is concerned, American studies show an average improvement. In short, the impact of PE on employees is multi-faceted, ambiguous and highly dependent on the context. The same applies to the impact on other stakeholders, although there is far less research available on that subject. According to American studies, the number of visitors to restaurants increases after a PE buyout. For students in commercial education, the opposite applies: a buyout leads to higher tuition fees and student debts, fewer educational resources and lower pass rates, among other things. The wellbeing and health of patients and residents in PE-funded hospitals and nursing homes in the US is also deteriorating. Anecdotally, there is even a study that links PE participation in local media in the US to lower turnout in local elections, because this media devotes less attention to local politicians.
PE firms achieve median profits of around 10%. There are large differences between the highest and lowest quartiles, but on an annual basis they outperform the S&P 500 index by an average of 3%. How stable are those profits? Put another way, are there some PE companies that consistently outperform others? Various studies indicate that there are, but that their stability is beginning to decline. There are several reasons behind this: the PE sector is maturing, and financial engineering and value creation techniques have become mainstream; there is a high employee turnover, with PE managers moving from one PE firm to another or setting up their own funds; it is becoming more difficult for PE to find proprietary deals in a buyout market dominated by investment banks; and, last but not least, there is a major influx of capital, leading to greater competition. Nevertheless, there are still PE funds and firms with top quartile performance, but only in less competitive markets. For low-performing PE firms, the returns are stable: they continue to systematically underperform. Research has also shown that individual PE partners have four times as much impact on the performance of a fund as the PE firm itself. Likewise, here, the sector specialisation of these partners is decisive. That makes it a good idea for investors in PE funds to pay attention to the partners involved when conducting their due diligence.
The PE market is most highly developed in the US, followed by the UK. That is why most of the studies available focus on these markets. There is more research needed into buyouts in Europe.