Private-equity firms are picky investors this year, but services and health-care companies are on their radar screens for potential takeovers and greater portfolio exposure. Both industries, PE firms say, will provide superior value in the current economic climate.
The second-quarter Rothstein Kass/CFO Midsize Private Equity Firm Barometer, which surveyed PE firms with assets of $150 million to $1 billion, shows that 52% of deals completed in 2012 have been in the services sector. Health care (which includes pharmaceuticals and biotech) came in second at 31%.
A substantial chunk of the 85 PE firms polled said they were weighing services-industry deals, particularly the information technology–services, financial-services, and insurance subsectors.
When asked about catalysts for services-sector value creation, 41% of the survey participants said services firms will get a lift from the recovering economy this year. (The survey was conducted in May.) But what’s also piquing their interest are reasonable valuations and plentiful deal opportunities, the survey found.
On the health-care front, a majority of the PE managers (61%) said they had either increased their holdings in health care, were weighing deals, or were investigating future investment. By subsector, 34% of those surveyed cited instruments and supply companies as targets; 28.3%, diagnostics; 23.8%, home health care; and 22.3%, appliances and equipment.
The PE managers surveyed were fairly unified about what will spur value creation in health care: the aging populace.
“Health care is rapidly evolving with advances in everything from cancer-fighting drugs to mobile health to noninvasive diagnostics and health-care analytics,” says Jeff Somers, a principal in the private-equity group practice at Rothstein Kass. “These diverse and innovative companies offer a wealth of opportunities to private-equity firms looking to take nascent technologies to the next level.”
By focusing too much on services and health care, private-equity firms could, of course, sow the seeds of lower returns. Somers warns that a “clustering” of deals in services or health care could have an impact on deal flow and valuations.
“Often, when you see a concentration of buyers in one or two sectors, you see a corresponding increase in valuations and prices,” says Somers. “Obviously, competition is a good thing for the companies in that sector, but it can impact profits for private-equity firms and may ultimately cause some to look elsewhere for more compelling opportunities.”
While PE firms are optimistic about opportunities, the deals in front of them obviously haven’t been compelling enough to move them off the M&A sidelines. The vast majority of the 85 firms in the survey have closed one or no deals to date in 2012. Thirty-five percent have closed two to three deals, and 11% have done four to five transactions. No funds reported closing five or more deals.
“The reasons behind the lack of more robust deal flow were varied,” says Somers. “Some cited a lack of dry powder, while others pointed to more add-on deals or a propensity toward fewer deals with more active involvement in portfolio companies.”
Rothstein Kass, a provider of professional services to alternative investment firms, polls private-equity fund managers quarterly.