Big is Better: Growth and Market Structure in Global Buyouts

Abstract

he word that best describes the recent trends in the private equity industry is “big.” The assets under management (AUM) for the entire industry have grown exponentially, deal sizes are getting larger, and the largest fi nancial sponsors are becoming even bigger on a relative basis, leading to a more concentrated industry. With no signs of these developments abating, we explore their potential ramifi cations in this article. In particular, we ask: How is competition within the industry likely to change? What does greater concentration mean for investors in private equity funds? And what is the probable impact, if any, on the ownership and acquisition premiums of buyout targets? To put these developments in perspective, consider that, at the end of 2006, the industry AUM were estimated to total more than $1.3 trillion. Compared with 1980, this implies a compound annual growth rate of 24%—substantially faster than the 11% at which the stock of public equity securities, private and public debt securities, and bank assets rose during this period. Between 2003 and 2006, commitments to private equity funds surged 260% to more than $400 billion. By far the largest share has gone into buyout funds whose investment pace has accelerated substantially. With the real cost of debt near historically low levels, and far below the earnings yield on equities, the global volume of leveraged buyouts (LBOs) skyrocketed to more than $700 billion in 2006, a fourfold increase compared with 2003. However, this record is unlikely to last for long: In the fi rst six months of 2007, buyout deals already totaled around $560 billion, or 25% of global mergers and acquisitions. Individual buyouts have become substantially larger, involving publicly-listed fi rms with greater frequency. In a signifi cant number of cases, the size of target companies have required sponsors to work together in so-called “club deals,” although more recently buyout fi rms seem to have preferred to include limited partners and even existing shareholders instead. Increasingly, general partners (GPs) look for global investment opportunities, while limited partners (LPs) seek to diversify their portfolios by committing capital to funds investing in different geographies. And while some buyout fi rms have recently fl oated special investment vehicles on the public stock markets in an effort to get access to “permanent capital,” others have decided to sell minority stakes through an initial public offering (IPO)—a step that was once viewed as heresy by the private equity industry. All of these developments are contributing to the profound changes taking place in the structure of the private equity industry. In analyzing how concentration in the industry has evolved over time, we start by examining the growth of individual funds and the drivers behind the observed growth differentials. Next, we evaluate the degree of concentration in fundraising and compare our fi ndings with the market concentration in other fi nancial industries. On the product side, we look at the impact of club deals and the extent of market contestability in an increasingly global buyout market. Finally, we discuss possible future growth strategies for buyout fi rms.