Mid-market: The next big thing?

Following an electronic polling session at the SuperInvestor conference in Paris last week, a clear majority of participants - LPs and GPs alike - pointed to mid-market buyouts as the main source of value creation in the near future. The following panel discussions and keynote speeches further highlighted the industry's expectations for this segment of the market.

The current leverage environment certainly plays a part in this downscaling trend. Debt may be available again, but nowhere near the levels witnessed during the boom years; facilities are more expensive overall, EBITDA multiples in the 3.5-4.5x region are now the norm, and relying on leverage to create value on the exit is no longer a viable strategy in most cases.

Indeed, GPs are now expected to work harder in order to see significant returns on their investments: grow the business by implementing significant operational improvements, consolidate a national market through strategic acquisitions, successfully expand a company on an international scale... Arguably, these challenges are easier met when dealing with a business that has yet to reach its full potential, hence the current competition for strong mid-cap assets.

A shift towards mid-market transactions would also resonate with the LPs' current expectations. At a time when investors are considering a reduction in their overall commitments and feel ambivalent about the fee structure of larger funds, managers with a more modest but also more focused strategy could very well stand out.

While these factors point towards growing interest for the mid-cap space going forward, GPs are not expecting a smooth road ahead. Firstly, the relative scarcity of resilient businesses, combined with a significant amount of dry powder waiting to be deployed on short notice, has sent prices soaring as of late. With average entry multiples hovering around the 10x EBITDA mark, generating strong returns will prove tricky and will require GPs to work hard at creating tangible value over the course of the investment - no small feat when the macroeconomic outlook for Europe remains bleak.

Moreover, a large number of mid-cap players are likely to be competing for a smaller fundraising pie. LPs may show an increasing appetite for this segment of the industry, but their cautious approach and the likelihood of them reducing overall commitments in the coming months will likely lead LPs to concentrate on a few standouts. According to several placing agents, up to 50% of generalist European mid-market vehicles could have real trouble fundraising and fall short of their targets. The lucky few will have to exhibit a strong track record and a clear strategy of differentiation to turn heads around.

Even if the mid-market space is attracting considerable attention at the moment, private equity players are not expecting a silver bullet. If strong returns are to be had, it will be through sheer hard work from GPs, and a careful selection process on the LP side. But this downscaling effort could also highlight the best in the private equity model at a time of increased public scrutiny: supporting economic growth through sound management and value-creating buy-and-build strategies.

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