Private Equity Exit Strategies – Navigating the Economic Cycle

June 30 2023

The value creation that Private Equity can bring to businesses, by contributing expertise across strategy, M&A and process enhancement is well documented and particularly applicable to PE partnerships with private family or founder owned companies. This value creation comes when growth is accelerated through customer expansion, operational efficiencies are improved, costs are reduced, IT systems are implemented and additional talent is employed.What is possibly more important but less well-documented is the value that is created through the “art of the exit” – being able to determine the right time to sell and identifying the best method of selling a company to maximise investor returns.PE firms typically aim to exit their investments within three to five years, with the timing dependent on the execution of their value creation plans, the current and future expected market conditions and the level of interest from potential buyers. PE funds carefully evaluate these factors, amongst others, when planning their exits in order to maximise investor returns.There are at least three main methods of equity release that Private Equity fund managers consider when planning to exit a business, often years in advance of the actual exit outcome:

  1. Initial Public Offering (IPO)
  2. Trade Sale
  3. Secondary Sale

Across Vantage’s private equity growth funds, trade sales have clearly been the preferred exit avenue for underlying Private Equity managers. However, the attractiveness of each of these strategies as an exit option varies significantly and is largely dependent on economic conditions, which is explored below.

Figure 1. Vantage Private Equity Growth Fund’s portfolio companies exit strategy, 2009 – 2022.

Initial Public Offering (IPO)

Over Vantage’s history, the use of IPOs as an exit route by underlying managers has varied significantly. As demonstrated in the graph below, the 2022 Australian IPO market was, in terms of volume of capital raised, the weakest in recent years with 107 new listings raising $1.1 billion in capital, down from 2021 which saw a significant IPO rush, with 241 listings raising $12.7 billion. Over the past 5 years, the average number of new listings remains on the lower end of that scale, being approximately 140 listings annually.

Figure 2. Annual number of IPOs in Australia, 2018-2022 (adapted from Ohm et al., 2022)

For Vantage funds, the 14 IPO’s to date (including 6 between 2019 – 2022) have generated the highest returns across the 3 strategies. To date, these exits have generated a 4.7x Multiple on Invested Capital (MoIC), with an average Internal Rate of Return (IRR) of 74% p.a.Empirical data shows IPOs exit valuations being materially higher than other forms of exit. A seller can often achieve an optimal pricing outcome by removing the discount that is typically applied to unlisted business valuations.Despite this, there are various drawbacks to IPOs as an exit route, which makes it increasingly difficult to use as a preferred avenue for PE managers. Most notably, IPOs require strong, favourable market conditions to be successful (the “IPO window is open”). Market volatility or a shift in market sentiment can result in a reduced investor appetite for new listings, impeding the fundraising process, often leading to delays or sometimes the cancellation of an IPO. In addition, due to regulatory constraints, IPOs rarely allow for a complete exit of all shares held, at listing. Generally, the PE fund will be required to retain a certain percentage of their shares for a fixed period, which both delays their ability to distribute returns to investors and introduces public market risk, which is not desirable for PE investors.Trade Sale

Trade sales are the most common exit route for Vantage investee funds. They are typically defined as a sale to another company (which is either listed or unlisted) and often already operating within the same or a similar industry sector. Generally, the acquirer is a business seeking to expand their existing operations to new geographic regions or looking to add to their existing product or services offerings or otherwise seeking to grow their revenue and earnings to ultimately increase the value of their shares.To date, the 45 trade sales completed across Vantage’s portfolios have generated an average IRR of 58% p.a. delivering an average 2.65x MoIC. Trade sales often provide a 100% exit for portfolio company and provide Vantage’s funds with strong and consistent returns, even during uncertain macroeconomic environments, making them a resilient route for exit.Trade sales provide an array of advantages which support ease of exit and enhance returns to investors.

  • Potential for a high return on investment: Trade sales can provide synergies to the acquirer’s business. Strategic buyers are often willing to pay a premium that other exit methods do not offer, due to the synergies and cost savings that can be achieved through the acquisition. In addition, if the target is an in-demand company, this can often lead to a competitive sale process which can drive up valuations, resulting in higher investment returns to the PE funds and their investors.
  • Faster exit: A trade sale can be completed more quickly than an IPO or a secondary buyout, which can be an advantage for private equity funds looking to exit their investment within a certain timeframe. Faster exits also means accelerated distributions to investors; and
  • Reduced risk: Trade sales reduce the risk of holding onto the portfolio company for longer than desired. Private equity firms face a risk of declining returns or even loss if they hold onto the investment for too long.

Secondary Sales

Secondary sales carry a number of similarities to trade sales. The major difference being they involve the sale of an investment by a PE fund to another often larger / offshore based, PE fund or financial institution / buyer, as opposed to a trade buyer.Across Vantage’s portfolio to date, the 20 secondary sales completed have generated 3.31x MoIC at an average IRR of 79% p.a. Although not as popular as trade sales in the portfolio, this method has also provided consistently robust returns for Vantage funds.PE firms who see value-creating opportunity in the target company may pay a premium to other acquirers. As is the nature of private equity, value is generated by implementing a number of value enhancing strategies across a certain hold-period to ultimately enhance the value of a business – providing significant upside to the right purchaser. However, secondary sale activity can be affected by macroeconomic conditions to a greater extent than trade sales, as well as the availability of dry powder (unused investment capital), meaning this exit route is not always open for PE managers seeking an exit for portfolio companies.Year in Review2022 saw global M&A activity remaining resilient despite the harsh macroeconomic headwinds that persisted through the year. According to Pitchbook’s 2022 Global M&A report, M&A value declined 13.7% from 2021 but remained strong relative to historical levels.The 2022 calendar year saw 10 exits across Vantage’s portfolio, 6 secondary sales and 4 trade sales, down from 15 exits in 2021. Although no exits from Vantage’s portfolios were via IPO in 2022, recent years have seen heightened IPO activity following a relatively mute period (6 IPO’s from Vantage’s funds in 2020 – 2021 compared to no IPO’s completed across the 2017 – 2019 period).Below, Vantage examines three sample exit case studies from Vantage’s Private Equity Growth Fund Portfolios to demonstrate how private equity managers are able to generate significant returns for investors across each of the exit strategies.
IPO – Best & Less Group (Allegro Fund III)
During July 2021, Allegro completed the successful exit of Best & Less Group via an IPO. Best & Less Group (ASX: BST) listed on 26 July 2021 at a share price of $2.16, giving it a market capitalisation of $271m. The realisation generated exceptionally strong returns for investors and resulted in Allegro being recognised as executing the Mid-Cap Investment of the Year at the 2022 AIC awards.This IPO represented a successful exit for both VPEG3 and its investors.
Trade Sale – MST Global (Odyssey Fund 8)
On 1 July 2022, Odyssey Private Equity Fund 8 (OPE8) completed the sale of MST Global (MST) to Komatsu Ltd (Komatsu), a leading global organisation listed on the Japanese stock exchange with a market capitalisation of $33 billion.

MST is a leading provider of unified communications products, digital infrastructure, real-time tracking and asset management solutions, predominantly for the mining and tunnelling sectors.  MST has a high-quality, global installed base and a strong reputation for product quality and customer service.Komatsu manufactures construction, mining, forestry and military equipment, as well as diesel engines and industrial equipment like press machines, lasers and thermoelectric generators. There were clear synergies for Komatsu in acquiring MST – with Komatsu announcing a focus in developing new technologies, equipment and solutions to support underground mining. MST’s leading-edge technology, which offers effective underground mining communication and data networks clearly fits this objective. Komatsu, given its’ size and reach, supplements MST’s technology by offering experience, expertise and capital to further develop the technology and expand MST’s offerings globally.This transaction marked another successful exit for VPEG3 and its investors.

Secondary Sale – RailFirst Asset Management (Anchorage Capital Partners)

Purchased by Anchorage Capital Partners in 2019 for a media reported $250m, RailFirst was repositioned to focus on Australia’s growing intermodal sector (ie. transportation of shipping containers.

According to the Australian Financial Review (Street Talk 4 September 2022) RailFirst was sold for a reported $425m to DIF Capital Partners and Amber Infrastructure. The deal was said to value RailFirst at 11x EBITDA and was enough to deliver about a 4x return on invested capital for Anchorage and an Internal Rate of Return of 40% p.a.

Under Anchorage III’s ownership, the Company made material investments in implementing new systems and processes which delivered strong sustainable growth. RailFirst doubled contracted earnings and materially increased contract tenor setting the company up for further growth post-sale.This sale to a financial buyer proved to be another successful exit for VPEG3 investors.

The Outlook

Australia has had a volatile few years of IPO activity with 2020/2021 seeing record-breaking high volumes, while the 2022 calendar year achieved a 10-year low. Moving forward, the broader outlook suggests this downtrend may revert if a softer economic landing occurs, as investors gain more certainty over the economic climate in the back half of 2023 and into 2024. Given the recent slowdown in new listings, there is thought to be a growing number of companies waiting for the window of opportunity to reopen. The reopening of the IPO window generally occurs with the listing of mid/large, low-risk companies with mature risk profiles, as investors seek to gain lower-risk public market exposure as they rebalance portfolios back to equities. These types of businesses are typical of Vantage’s portfolio, with the Vantage investment strategy focusing on lower-risk, mature companies with strong cash flows – meaning the IPO window may reopen sooner for Vantage’s underlying funds compared with other sectors within the alternative asset class (e.g. Venture Capital).Meanwhile, Trade sale opportunities could reduce as corporations become increasingly hesitant to make strategic acquisitions in the midst of recessionary fears. Instead, some corporations may need to focus on shoring up their balance sheets and cash reserves in preparation for an economic downturn.
This is a general statement however, and trade sale opportunities will likely continue to be relevant with the right strategic buyers.Secondary sales are expected to take-up an increasing proportion of PE exit activity in 2023. According to Pitchbook 2023 data, the number and size of larger and often offshore based, PE funds and financial buyers have steadily expanded over the years while the number of corporate buyers have remained relatively fixed. In addition, PE firms globally are currently holding record-levels of dry powder, estimated to be $1.3 trillion according to Pitchbook’s 2023 Global M&A report. These PE Managers will need to deploy this capital to ensure alignment with investing mandates and are likely to find high quality targets in other PE-backed companies especially within the Australian and New Zealand markets which is the domain of Vantage’s underlying portfolio.Overall, the current economic environment is expected to generate some near-term uncertainty. It is impossible to know how long the current macroeconomic challenges will persist and the magnitude of its’ impact on exit activity. However, there is nothing to suggest that the longer-term outlook for private equity will not remain positive, with private market returns expected to continue to outpace public market returns across the medium to long term time frames, as they have historically demonstrated in Australia since retruns data was first collected in the late 1990’s.
For Vantage, the investment strategy continues to be to focus on making investment commitments to PE funds managed by the top quartile performing PE managers in Australia and New Zealand, who are able to create value in their portfolio companies throughout the economic cycle. Based on discussions with Vantage’s underlying PE managers, a number of exit alternatives are currently being explored for many underlying portfolio companies, particularly those within Vantage’s VPEG2 and VPEG3 portfolios, with these exits expected to be completed through the 2023 calendar year, ultimately delivering further distributions and strong risk adjusted returns to Vantage Fund investors.