Auerbach: ‘nervous’ in high-priced, strong-fundraising environment

Andrea Auerbach is nervous — and when someone who leads a team that takes more than 2,000 general-partner meetings a year is nervous, people may want to listen up.

Auerbach, global head of private investment research at consultancy Cambridge Associates, said U.S. PE fundraising appears as strong as ever this year, heading for what could be the second largest year for commitments to U.S. private equity funds since 2007.

This strong environment comes when EBITDA purchase-price multiples are creeping up above 10.5x and average leverage multiples are hovering past 5x, according to Cambridge research.

“I’m really intrigued with where this market might be going,” Auerbach said during a keynote speech at an annual secondaries-market dinner in New York this week. “I think a lot of folks think the music is still playing, things are still happening, capital is still definitely coming into the space. What does it mean for returns? As I mentioned, we’re nervous.”

Cambridge has been in tough conversations with GPs coming back to market who tout their targets at 2x or 2.5x return and 20 or 25 percent internal rates of return. Cambridge studies the returns of all deals done during a calendar year. The median return for all U.S. PE deals in 2014 was currently estimated about 10 percent gross, Cambridge found.

The GPs’ touted numbers make for sometimes awkward conversations.

“We use this to have fairly meaningful discussions with managers we’re thinking of working with or performing due diligence on,” Auerbach said. “This is the market, not 2x or 2.5x. This was surprising to me. I was … not happy with managers that keep coming in and telling me what their return target is because I know they’re not hitting it.”

Distributions also appear to be slowing and may have peaked, Auerbach said. From 2011 to 2015, GPs distributed more than $600 billion to LPs. Projected distributions this year may come in at $72 billion, Auerbach said. If that happens, capital coming into the industry, which remains strong, will be new capital looking for exposure to PE, she said.

“It will be interesting to see where they want to put that capital,” she said.

Finally, all this capital coming into U.S. private equity in the high-priced environment has built up a capital overhang, measured at $474 billion last year, the largest amount Cambridge has found, Auerbach said. This includes $204 billion in the middle market and $202 billion in the mega-market, Cambridge’s numbers showed.

Cambridge is watching all the signals very closely.

“If you think the music is still playing, and multiples are still high, interest rates are still low and it’s just going to keep going in this zone that we are in, if I’m a manager I’d be trying to exit as fast as possible,” she said.

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Photo courtesy of Cambridge Associates