Private Company Fundamentals Drive Rapid Enterprise Value Growth
Private company enterprise value growth continued in the third quarter as the Lincoln Private Market Index (Lincoln PMI), formerly known as the Lincoln Middle Market Index, grew 6.4% in Q3 2021, the second-highest quarter-over-quarter growth since its inception seven years ago. This growth was primarily a function of strong fundamental performance among private businesses, even as U.S. economic growth slowed in the third quarter.
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Lincoln International releases proprietary Q3 Lincoln Private Market Index (Graphic: Business Wire)
In fact, private businesses saw last twelve months (LTM) EBITDA grow by an average of 4.5% quarter-over-quarter, while enterprise value multiples increased by only 0.1x since Q2 2021. Despite the muted quarterly change in enterprise value to EBITDA multiple, these multiples reached a record high of 11.0x EBITDA, topping in almost 1.0x higher than the historical 3-year average.
“The trends observed in the Lincoln PMI in Q3 2021 once again demonstrate that fundamental performance is the long-term driver of enterprise value growth in private equity backed businesses,” noted Steve Kaplan, Neubauer Distinguished Service Professor of Entrepreneurship and Finance at the University of Chicago Booth School of Business, who assists and advises Lincoln on the Lincoln PMI.
Portfolio Company Growth Skyrockets as Private Companies Performance Paces with Public Company Levels
Private market enterprise value growth was even more robust than public market growth in Q3 2021. The S&P 500 enterprise values were stable during the third quarter of 2021; however, a decline in S&P 500 enterprise values likely would have resulted if not for robust operating performance of its constituents, similar to the trends observed in the Lincoln PMI. To this end, while the average S&P 500 enterprise value multiple declined 0.6x in the third quarter of 2021, LTM EBITDA grew 9.2% during that time. Notably, during the month of October 2021, the S&P 500 enterprise values grew 5.9%, rebounding from the high volatility observed in Q3 2021, especially September.
According to an analysis of private companies in Lincoln’s proprietary database, between 2021 and 2020, private companies with greater than $150 million of EBITDA outpaced smaller private company growth over the same period. The average year-to-date revenue and EBITDA growth of private companies was 13% and 7%, respectively. Moreover, these larger private companies with greater than $150 million of EBITDA grew at an even faster rate as year-to-date growth on a revenue and EBITDA basis reached 15% and 13%, respectively. The growth observed is almost double that of the levels observed between a sharp increase from 2018 and 2019 where revenue and EBITDA grew just 7% and 3%, respectively, across the entire population of portfolio companies.
“Growth-stage private businesses are scaling at a breathless pace,” noted Ron Kahn, Managing Director and Co-Head of Lincoln’s Valuations and Opinions Group. “Private company growth today has nearly doubled relative to the pace of growth before COVID-19. As we round out 2021, the challenge these companies face is ensuring that supply chain breakdowns and hiring hurdles do not become the limiting factors slowing their stride.”
Robust Private Credit Market Prepares for LIBOR Transition
The proliferation of covenant-lite loans, which Lincoln defines as those without any financial maintenance covenants (not including springing revolver covenants), is resurfacing across the credit markets as lenders look to remain competitive. This trend first started in the broadly syndicated loan market but in the most recent months has trickled down into the private credit market.
Based on an analysis of private credit loans issued in Q3 2021, Lincoln noted approximately 20% of loans were covenant lite and an additional approximately 50% of loans included only one covenant, primarily a leverage-based covenant. Comparatively, just half as many loans issued during the pandemic were covenant lite whereas a similar percent had only one covenant. Despite this loosening of covenants, the average leverage multiple was 5.0x EBITDA, which is in line with the historical average; similarly, the average equity cushion was 55%, which is above historical average levels due to record enterprise valuations. This is consistent with the results of Lincoln’s Senior Debt Index, which was introduced a year ago, as the median loan-to-value was at its lowest level since inception in 2014.
Additionally, lenders are preparing for the transition away from the London Interbank Offered Rate (LIBOR) as a reference rate for new issuances after December 31, 2021, as U.S. regulators citing any deals issued after such date as a “safety and soundness risk.” Lincoln continues to observe a rush to use LIBOR as the base rate in new issuances. Based on Lincoln’s analysis of recent transactions in the private credit market, while some larger direct lending deals have priced based off of the Secured Overnight Financing Rate (SOFR), deals pricing based on alternative rates in the private credit market are the exception, not the rule.
Nearly all loans issued in Q3 2021 analyzed by Lincoln include fallback provisions to address the move to an alternative reference rate once LIBOR is no longer published in June 2023. Of these new issuances, approximately two-thirds of agreements either defined a specific reference rate which must be used or defined a reference rate which likely will be used (subject to a lender election). In each instance, SOFR is the reference rate defined as either the replacement rate or the defined reference rate should the borrower not elect to use another acceptable reference rate.
“The lack of private market activity tied to reference rates other than LIBOR is notable at this stage of the transition, especially given the apparent market enthusiasm around SOFR as the preferred replacement rate,” added Ron Kahn. “As the year comes to a close, it will be interesting to see how lenders account for the difference between LIBOR and SOFR in new originations, either through changes to contractual spread requirements or via a spread adjustment.”
About the Lincoln Private Market Index
The Lincoln PMI, previously known as the Lincoln Middle Market Index (LMMI), is the only index that tracks changes in the enterprise value of U.S. privately held companies—primarily those owned by private equity firms. With the Lincoln PMI, private equity firms and other investors can benchmark private companies’ performance against their peers and the public markets.
This index is differentiated from other indices as it (1) tracks enterprise values of private companies over time; (2) is based on valuations rather than executive surveys; and (3) covers a wide sampling of companies across a range of private equity firms’ portfolios.
The Lincoln PMI seeks to measure the variation in private companies’ enterprise values by analyzing the aggregate change in company earnings as well as the prevailing market multiples for approximately 700 private companies each generating less than $100 million in annual earnings. The index is calculated using anonymized data on an aggregated basis by Lincoln’s Valuations & Opinions Group, which has distinctive insights into the financial performance of thousands of portfolio investments of financial sponsors, business development companies and private debt funds.
The methodology was determined by Lincoln in collaboration with Professors Steven Kaplan and Michael Minnis of the University of Chicago Booth School of Business. While other indices track changes to a company’s revenue or earnings, the Lincoln PMI is different in that it tracks the total value of these companies. Significantly, the large number of private companies used to create the Lincoln PMI helps ensure that the confidentiality of all company-specific information used in the Index is maintained.
Important Disclosure
The Lincoln Private Market Index is an informational indicator only and does not constitute investment advice or an offer to sell or a solicitation to buy any security. It is not possible to directly invest in the Lincoln Private Market Index. Some of the statements above contain opinions based upon certain assumptions regarding the data used to create the Lincoln Private Market Index, and these opinions and assumptions may prove incorrect. Actual results could vary materially from those implied or expressed in such statements for any reason. The Lincoln Private Market Index has been created on the basis of information provided by third-party sources that are believed to be reliable, but Lincoln International has not conducted an independent verification of such information. Lincoln International makes no warranty or representation as to the accuracy or completeness of such third-party information.
About Lincoln International
We are trusted investment banking advisors to business owners and senior executives of leading private equity firms and public and privately held companies around the world. Our advisory services include mergers and acquisitions and capital markets advisory for the mid-market. We also provide valuations and fairness opinions and joint ventures advisory services. As one tightly integrated team of more than 700 professionals across 16 countries, we offer an unobstructed perspective, backed by superb execution and a deep commitment to client success. With extensive industry knowledge and relationships, timely market intelligence and strategic insights, we forge deep, productive client relationships that endure for decades. Connect with us to learn more at www.lincolninternational.com.
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