Since 2006, the number of private equity-backed companies in the United States has more than doubled to approximately 8,000 in 2017, far exceeding the 4,300 companies whose equity is traded on public markets. Massive inflows of capital to private markets have continued, with $212 billion pouring into North American private equity in 2018 alone.
McKinsey & Company’s Global Private Markets Review 2019, “Private markets come of age,” details these trends for all major private market segments, including private equity, closed-end real estate, private debt, natural resources and infrastructure. The report found that North American private equity fundraising in 2018 was down 13.5 percent from 2017’s record amount, but still posted the industry’s third-strongest year ever.
“This may reflect some ‘lumpiness’ in the timing of large raises, rather than a cyclical decline, however, as approximately $190 billion in additional fundraising was pending at year-end for North American funds,” McKinsey pointed out. McKinsey’s analysts, led by Andrea Chau, characterized the year as “easing off the gas,” and pointed out that assets under management rose to an all-time high, to about $5.8 trillion globally.
FreightWaves was particularly interested in North American private equity and how the growth of the overall industry, larger deal sizes and higher multiples paid in buyouts affected the transportation industry. David Sawyer, vice president at Linx Partners, an Atlanta and New York-based private equity firm specializing in industrial companies, spoke with FreightWaves. Sawyer served on the board of Grammer Industries, an asset-based chemical hauler which Linx successfully exited in October 2018.
Sawyer commented, “There are pockets of value in the transportation marketplace that are starting to become more and more recognized outside of the 3PL [third-party logistics provider] craze that we’ve witnessed the last, call it five years – other areas where there are investable dollars that can go to work to generate an attractive return.” Sawyer continued, “One area of interest is repair and maintenance; investors are finding unique areas to drive performance.”
Sawyer added that private equity has also become more willing to invest in asset-based companies, but stressed that “there has to be something unique about what you haul or how you haul it.” Investors may choose to avoid dry van carriers whose capacity is largely treated like a commodity – they’re looking for niche businesses that are highly valued by their customers.
“Dollars going into transportation are trying to solve big problems for this country, the future of the industry, and our economy – the way we buy and transport goods,” Sawyer said.
Indeed, private equity has grown at an eight percent compounded annual growth rate (CAGR), according to McKinsey, despite much more widely dispersed returns than equities-based mutual funds. While mutual fund returns are located in a tight band, the top quartile achieved annual returns between 20 percent and 50 percent over the past five years, while the bottom quartile lost as much as 30 percent.
The skill of individual investment managers certainly plays a role in the dispersion of returns on private equity investments; however, the size of the investments matter, too. The approaches investors take to value creation in lower middle market, middle market, and the large buyout arena can be quite different.
“I think less and less it becomes a financial engineering game, and more about creating the best company possible, which comes from implementing certain strategic initiatives,” Sawyer explained. “For example, leveraging technology by bringing on a data scientist at a trucking company, or a specific CFO, or focusing on a highly valued niche market.”
Despite widely varying results, limited partners continue to see overall improved performance from general partners. Internal rates of return (IRR) fall along a “J-curve” in private equity; investors initially see negative returns after making an investment and then begin to see cash returned to them. According to McKinsey, funds raised in the years 2012 to 2015 broke even in year two and reached an average IRR of 10 percent in year three, much faster than previous vintages.
Even if the economy takes a downturn and private equity fundraising slows, there is enough “dry powder” on the sidelines – capital committed by limited partners but not yet deployed by general partners – for private equity firms to continue to make investments for years to come. McKinsey reported that globally, private equity dry powder reached a record $1.2 trillion in 2018 after growing at a 13 percent CAGR from 2012 to 2017.
FreightWaves expects private equity’s growing interest in a diversifying array of transportation and logistics companies to continue to drive consolidation, advances in technology and operational excellence at an accelerating pace.