The sinking cost of debt, a mountain of private equity dry powder, and larger equity investments are helping push LBO purchase price multiples to all-time highs, with a substantial number of third-quarter buyouts sporting multiples in the low-twenties.

During the third quarter, the average purchase price multiple on U.S. LBOs (including fees) jumped to 12.9x pro forma adjusted EBITDA, pushing the year-to-date average through September 2019 to 11.5x EBITDA, up almost a full turn from the average of 10.6x in 2018, according to LCD. That figure marks the highest recorded average multiple for LBOs since LCD began tracking this data in 2000.

Pre-crisis, average annual purchase price multiple peaked at 9.7x in 2007.

Higher multiples are to be expected in the late stages of the economic cycle, and can vary substantially quarter to quarter, depending on deal count. Yet an LCD review of third-quarter LBOs shows that deal multiples in the high teens and low twenties are not limited to the usual suspects of upstart tech buyouts and public-to-private deals, where high growth projections traditionally have been employed to justify such numbers.

For example, several secondary, private-to-private transactions have carried valuations well into the high teens, including the buyout of software firm Jaggaer Inc. by Cinven Group Ltd. (from Accel-KKR) in August, at 16x, and the $4.25 billion sale of healthcare services firm Press Ganey Holdings Inc. (from EQT) to an investor consortium including Leonard Green & Partners and Ares, at an 18.8x multiple in July, sources said.

Of course, a number of high-profile deals have added extensive adjustments to underlying earnings calculations to justify historically high purchase prices.

Nestle Skin Health, now known as Galderma, carried a multiple of 15.1x, based on pro-forma adjusted EBITDA, for its roughly $10.2 billion buyout by EQT and the Abu Dhabi Investment Authority, or ADIA, during the third quarter. However, the deal multiple measured in the low 20s based on the company’s adjusted cash earnings, before extensive pro forma adjustments, according to sources familiar with the transaction.

One private equity bidder on the deal said his firm came close to winning the transaction, but was outbid "by a number that would blow your mind. People are not horsing around in this market."

Market sources also report that other deal multiples are clocking in at the low twenties, even based on pro forma earnings. Aldevron, a Fargo, N.D.–based supplier of plasmid DNA for cell and gene therapies, in September was bought out at a 20.5x pro forma multiple by EQT in a deal that included $1 billion in debt financing.

High multiples, bigger checks
While these lofty purchase price multiples can raise eyebrows, private equity sponsors are fueling the build-up increasingly via equity, rather than further leveraging up the firms they acquire. Equity contributions for LBOs so far in 2019 have averaged 44.5%, compared to 40.5% in 2018, according to LCD. The current level is the second-highest on record, behind 45.7% in 2009, shortly after the financial crisis.

Looking at the data another way, out of the 11.5x year-to-date purchase price multiple, the total equity to EBITDA ratio (which consists of new sponsor equity and rollover equity, if any) accounts for 5.5x, with the debt portion at 5.8x. Last year, the average purchase price multiple was 10.6x, but the debt multiple was a touch higher, at 5.9x, but most of the 2019 increase in purchase price comes from the equity component. It is worth noting, however, that at 5.9x the average debt/EBITDA ratio is nearing the all-time high of 6.1x in 2007.

Historically high multiples belie what some are calling a tale of two economies. Ebullient M&A valuations have been at stark odds with bond market sentiment through the summer and early fall, what with uncertainty regarding the economy and the future path of interest rates.

"While there is talk about softness with the U.S. economy and the global economy, the numbers we’re seeing from the private companies are tracking pretty well," said Jeremy Swan, managing principal at CohnReznick, an accounting and advisory firm. "When you look at where interest rates are and the debt capacity and the ability to finance these deals, debt is still readily available at highly attractive rates for the right names."

Likewise, there remains substantial amounts of undeployed capital for U.S. deals that have helped prop up M&A values. Based on figures from Preqin, dry powder for North America–focused private equity stands at $881 billion as of October 2019.

Still, overly high valuations are likely one reason that the number of PE-led deals has declined this year, with LBO transaction volume through the first three quarters of the year measuring $188 billion, versus $223 billion in the analogous period last year.

"One could argue that we are in a bubble, and have been in that bubble for a few years now, if you look at leverage multiples, valuation, and raised capital at PE funds," Swan added. "Now, the challenge is going to be, as a PE investor, buying into a market with at- or near-record valuation levels, it becomes much harder to get [the] returns that they have come to expect. Return expectations have had to come down, and we’ve seen a lower success rate on getting M&A deals across the finish line."

"The issues you can live with as a PE fund paying a multiple of 6x are substantially harder to swallow with a 12x, or even 16x multiple," Swan said.

This story was written by Alexander Saeedy, who covers the U.S. leveraged loan market for LCD.

LCD is an offering of S&P Global Market Intelligence. S&P Global Ratings is a separately managed division of S&P Global.

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