Barbarians at the Gate

There is a long running debate in private equity investing.

Do the funds, which have won the moniker “Barbarians at the Gate”, create value by financial chicanery, or by actually improving the businesses they’ve bought?

There has long been skepticism about the latter, as the $3.5 trillion industry’s often aggressive approach is sometimes portrayed in a bad light. Private equity companies that swept into the ambulance business due to its “tremendous growth potential,” for example, reportedly instilled aggressive billing practices and pushed some operators to bankruptcy.

However, researchers have found hard evidence that these funds can actually drive returns through improving the business.

Fintech firm CEPRES analyzed thousands of private equity-backed companies, and found that there has been a steady and huge jump in their average compound annual earnings growth rate (measured by EBITDA) since the financial crisis.

Here is CEPRES:

“Further, CEPRES found that increase in valuation of companies post GFC is driven more by EBITDA Growth than prior years. This evidence supports the view that Activist PE Fund Managers are effective and able to deliver on the promise of delivering returns through Value Creation. CEPRES also found that valuations are currently being driven by increased market pricing – commonly called Multiple Expansion.”

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Separately, recent research by the London Business School has a similar finding.

Private equity-owned portfolio companies significantly outperform similar non-private equity owned companies in terms of EBITDA, sales and assets post-buyout, according to that report.

“Our research shows that private equity-owned companies achieve significantly better operating profitability, assets and sales over the first three years of private equity ownership compared with matched companies that are similar but not owned by private equity funds,” said Florin Vasvari, professor of accounting at London Business School. “The results show that while GPs focus on growth they also generate significant operational improvements that likely contribute to that outperformance.”

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