Private equity valuations have built up a reputation for being overvalued, overinflated, or basically just made up.
The Bank of England and Financial Conduct Authority have both warned of the “opaque” valuations in private equity, while a media narrative has formed that private equity companies are ‘marking their own homework’.
Of course, it’s a fair question, and companies surely must be eager to make it seem like the companies they own are worth a lot more than reality.
Nevertheless, when examining the process behind how private equity companies value their holdings, the narrative starts to become a bit less clear.
While there are clearly high profile examples of private equity holdings being overvalued, such as Wework, most companies are fairly sensible with judging the value of their portfolio, trying to make sure they reflect the market.
Private equity companies will seek to compare their holdings to publicly listed companies, and revalue them based on how those companies have moved.
This is for the simple reason that it looks very bad for a private equity company to sell off a company for much lower than they had valued it for.
Listed private equity is the sector that is perhaps the most quantifiable within the private equity universe, as while the assets themselves may not be priced by the market, the value of the entire trust is.
“Historically it has been very rare to see listed private equity trusts announce sales at below the carrying value. This in our view implies that valuations are conservative,” said William Heathcoat Amory, managing partner at Kepler Partners.
“Deal activity has slowed certainly, but there is no evidence that realisations are being done at significantly below carrying values. So this also suggests that valuations are at least fair.”
Ben Wilkinson, CFO of venture capital firm Molten Ventures, said that the firm could show that its valuations were accurate by “exiting them above where we hold them”.
“That’s all we can really demonstrate,” he said, adding that “when public markets move up, we took the same impact into our portfolio”
However, he did caution: “It’s subjective, especially in early stage businesses. You’re never going to be able to sit there and say ‘this is the definitive valuation’”.
Private equity giant Hamilton Lane argued that even when looking into the fundamentals, valuations still hold up.
“How can you come to private markets thinking we are expensive, concentrated and skewed towards the large?”
Juan Delgado-Moreira, co-ceo of Hamilton Lane
Revenues for companies in Hamilton’s Lane North American Buyout fund were up over 15 per cent in 2022, compared to just over 10 per cent for the S&P 500, while operating profit growth similarly stayed ahead in private markets.
The numbers were slightly reduced for 2023, but still showed revenue growth slightly ahead for Hamilton Lane’s companies, with operating profit growth just below five per cent, compared to basically flat for the S&P.
Meanwhile, as public markets move to greater concentration, such as the domination of the Magnificent Seven in recent months, attacking private equity valuations by comparing them to listed equities has become a bit of a harder job.
“How can you come to private markets thinking we are expensive, concentrated and skewed towards the large?” asked the co-CEO of Hamilton Lane Juan Delgado-Moreira.
Of course, private equity does still have a skew towards being more expensive. Kepler’s Heathcoat Amory said that relative to quoted markets, valuations within the listed private equity universe were “optically higher”.
He explained that the average enterprise value to operating profit ratio was 16 times for listed private equity, compared to 11.9 times for the MSCI World.
“However, there will be lots of adjustments that one might make based on the relative sector make-up of private equity portfolios and that of the MSCI World,” said he explained.
Private markets tend to invest far more in companies that are highly valued relative to their earnings, such as tech companies, while investing less in more volatile sectors like real estate and energy.
Tim Levine, CEO of listed venture capital investment trust Augmentum Fintech, was adamant that his businesses were not overvalued compared to other fintech companies.
“As the public markets went up to crazy levels, I think the peak forward revenue multiple on the Global FinTech Index was over 20 times, and our top 10, which was nearly 80 per cent of the portfolio, was trading at about five and a half,” said Levine.
Meanwhile, Heathcoat Amory noted that listed private equity portfolio companies “are growing in aggregate at significantly higher rates than that of the MSCI”.
“Our businesses are growing on average three times three to four times the rate of the Global Fintech Index,” added Levine, but noted that the index’s forward revenue multiple was down to about six and a half, but “we’re still less than five”.