With an astounding 58% of current global PE returns coming from multiple expansion, contracting valuations put the whole industry under pressure. Organic growth, buy-and-build and operational improvements will now have to drive performance. But with a meager 1% GDP CAGR Europe appears to be in a disadvantaged position.
The good news: European private assets still grew on average 7% overall (incl. M&A) over the last 5 years. Even better is that PE-held companies managed to outperform privately held ones by at least a factor of 2. They excel at achieving organic growth and amplify this with add-ons. Additionally, PEs overachieve margin expansion averages. However, the willingness and ability to find and drive organic growth and M&A strongly varies by investor. While there is fundamentally no right or wrong here in terms of strategy pursued, our data shows that the best performing European PEs are in fact differentially good at realizing both types of growth.
To enable investors to capture organic growth we analyzed on a sector-level where to find it in today’s economy. In aggregate, the usual suspects (e.g. TMT) stand out, but when digging deeper, many niches in less obvious sectors display high growth. Means can be deceiving. For instance, more than a third of the fastest-growing companies (>15% organic growth CAGR) operate in lower-growth industries (industrials, materials, consumer). We also find that growth is rare, with less than 24% of companies exceeding 15% annual organic expansion. What is more, few combine it with profitability and in fact less than 4% manage to achieve such a growth level while also delivering >20% EBITDA margins. It means that trade offs are likely a necessity to secure enough deal flow.
The attraction of buy-and-build is that it enables multiple arbitrage irrespective of the overall valuation curve. On top of this, we find that businesses engaged in continuous M&A are able to expand EBITDA margins much quicker than those that do not (+2.4pp vs 0.9pp in 17-22). This means scale benefits and operating synergies are real. We identified the best sectors and niches to find market fragmentation by analyzing their concentration index (HHI). Overall, the services sector is least consolidated. In addition, we compared levels of PE-ownership and ongoing M&A as a method to identify paths into less well-trodden spaces for investment.
Based on our findings, we recommend European investors sharpen their sweet spot in order to capture much-needed growth. This also includes making it explicit which flaws you are willing to accept, because perfect assets are rare and expensive. PEs should also get more creative to find multiple arbitrage opportunities that do not rely as much on overall market multiples, such as buy-and-build as well as profile enhancement to drive an attractive exit rating. Lastly, we urge investors to think more creatively than to just chase the latest hot TMT vertical. Growth is granular and can be found in a wide range of sectors. There is no denying that PEs will have to work harder to do well in the next decade. Smart data-driven sourcing strategies are one place to start.
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