In Q4 2021, private company enterprise values grew 3.9%, bringing the Lincoln Private Market Index (Lincoln PMI) once again to an all-time high. Enterprise value growth continued to be driven by fundamental performance as last twelve months (LTM) revenue grew 5.5% and LTM EBITDA grew an average of 3.4% quarter-over-quarter based on information from Lincoln International’s proprietary private market database.
The strong performance observed in 2021 capped off a year which marked continued recovery from the COVID lows. LTM revenue and EBITDA in 2021 grew 12.5% and 8.2%, respectively, from 2020—closing out the year markedly above forecasts. Of M&A transactions which closed in Q4 2021, the average buyout multiple was 12.0x EBITDA, which is above the pre-COVID 2019 average buyout multiple of 10.4x.
Private Credit Risk Appetites Heighten Across Industries
The private credit market grew 7.9% in 2021 according to Lincoln International’s Senior Debt Index. As lenders searched for ways to remain competitive, the number of new underwritings closing at 7.0x or above reached an all-time high in 2021, increasing more than 89% over the prior year. While the average leverage multiple in aggregate remained around 5.0x, in 2021 lenders took new steps to break through the competition, including relaxing covenants and lending at higher leverage multiples than previously thought tenable.
Technology deals in recent years have consistently had higher leverage multiples, often in excess of 6.5x. While technology transactions remained at the forefront of higher EBITDA-based leverage, technology deals were increasingly completed in the context of recurring revenue and little-to-no EBITDA.
More specifically, Lincoln International observed a 62% increase in technology deals underwritten to recurring revenue in 2021 when compared to 2020. Despite this elevated leverage and prevalence of recurring revenue-based loans, lenders’ loan-to-values (LTV) remain relatively in line with historical levels, indicating that lenders’ confidence is boosted by higher equity cushions.
“Where once technology companies were unique in their ability to raise debt with higher leverage multiples, last quarter other industries—from healthcare to industrials—unlocked access to leverage levels exceeding historical norms,” said Ron Kahn, Managing Director and co-head of Lincoln International’s Valuations & Opinions practice.
Further impacting lenders’ balance sheets, the average hold size of transactions closing in Q4 2021 increased 62.3% from the pre-pandemic average. Coupled with the increased hold sizes, tranche sizes rose above their pre-pandemic levels, resulting in increasingly concentrated investments in single credits in lender portfolios.
Supply Chain Issues, Labor Shortages and Inflationary Pressures Slow EBITDA Growth
Based on an analysis of a subset of companies which self-reported an impact from supply chain, labor shortage, and inflationary pressures, most notably those in the consumer and industrials industries, Lincoln International observed EBITDA margins contracting on average by 3% in the fourth quarter. Anecdotally, Lincoln has observed situations in which shipping costs have increased over 100% year-over-year or companies have been forced to seek out alternative methods of shipping.
While the aforementioned cost pressures have led to a decline in EBITDA in many cases, affected companies often reported strong top line growth due to continued demand for products and services. In some instances, demand was higher than supply companies could fulfill, leading to record order backlogs heading into 2022. Private companies’ Q4 2021 LTM revenue growth of 5.5% may likely have been even higher if not for these supply constraints. In 2022, the subsiding of cost pressures will be a key condition of private company growth.
“We have seen time and time again that business fundamentals drive long-term growth in private markets,” said Steve Kaplan, Neubauer Distinguished Service Professor of Entrepreneurship and Finance at the University of Chicago Booth School of Business, who assists and advises on the Lincoln PMI. “Private companies that take measures to offset supply chain, labor shortage and inflationary pressures—whether it be price increases, cost rationalization, or alternative material sourcing—can reach their full growth potential.”
Public Market Volatility: A Sign of Things to Come for Private Markets?
The start of 2022 for public equity markets has been volatile, with the S&P 500 decreasing over 5% in January alone, which was the index’s largest monthly decline since March 2020. As we have observed in the past, the public equity markets are often a harbinger of things to come in the private markets. However, with private company values closely tied to business fundamentals, private markets may provide a safe haven for investors seeking shelter from the S&P’s whiplash.
To that end, private market valuations in 2022 hinge on whether companies can keep pace with the growth experienced in 2021. Based on self-reported 2022 private company budgets, revenue is expected to grow 9.7% and EBITDA is expected to grow 6.2%—a decrease of 2.8% and 2.0%, respectively, year-over-year. However, these growth targets indicate that private companies do not expect business headwinds to curtail growth.
“The inflationary panic felt in public markets is not shared by private business owners. Our clients believe that cost pressures will subside, and today’s price increases will be passed on to end customers,” noted Kahn. “However, should businesses fail to mitigate cost pressures, enterprise value compression in 2022 becomes a real possibility.”
About the Lincoln Private Market Index & Lincoln Senior Debt Index
The Lincoln PMI 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 600 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 International 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.
Further, in 2020, Lincoln launched the Lincoln Senior Debt Index which provides insight into the direct lending market as a fair value index tracking the total return, price, spread and yield to maturity of direct lending securities. The index is developed using much of the same data as the Lincoln PMI and the methodology was determined by Lincoln in collaboration with Professor Pietro Veronesi of the University of Chicago Booth School of Business.
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 their portfolio companies and to public and privately held companies around the world. Our services include mergers and acquisitions advisory, private funds and capital markets advisory, valuations and fairness opinions and joint ventures advisory. As one tightly integrated team of more than 725 professionals across 16 countries, we offer an unobstructed perspective on the global private capital markets, 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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