LONDON, March 15 Big private equity deals have been grabbing headlines, but it is the smaller deals in Europe that are delivering the returns, leaving some investors pondering the wisdom of pouring more cash into the industry's giants.
Mid-market European private equity funds delivered average internal rates of return (IRR) of 17.2 percent in the period 1990-2011 compared with 9.1 percent for all buyout funds, according to research published this week by the European Private Equity and Venture Capital Association (EVCA) using Thomson Reuters data.
"The top performing mid-market managers rely less on leverage and multiple expansion. Instead, performance comes from growth and operational improvement," Craig Donaldson of the EVCA said in the report.
Funds in the mid-market category, defined as those having raised between 250 million euros ($324 million)and 1 billion euros, say that performance is prompting increased interest as investors get more selective about the funds they choose.
"Interest in medium-sized private equity groups is big," Daniel Flaig at Swiss-based medium-sized private equity firm Capvis told Reuters.
"Their targets, medium-sized companies, can be influenced more easily, making it easier to generate good returns. Also, the very large PE transactions from the 2006/07 period have not done so well. Therefore, some investors are not inclined to give them more money for big deals," Flaig said.
The mega buyout groups are still the ones with the most available to invest, with an aggregate $122 billion. Large buyout funds have $96 billion, mid-market $82 billion and small $47 billion, according to Preqin, which provides data and research on private equity and other investments.
Asked what fund type offered the best opportunities in 2013, 39 percent of investors surveyed by Preqin said small to mid-market buyouts, compared to 19 percent who favoured large to mega buyout funds.
Advent International, which targets companies worth between 200 and 2 billion euros, pulled in 8.5 billion euros in November in the biggest private equity fundraising since the financial crisis. This contrasts with rivals more focused on the larger end of the buyout market that have struggled to reach their fundraising targets.
Some say the returns on larger deals are lower because competition to win them drives up valuations.
"Investors increasingly doubt that value creation is as big in large buyout funds as in smaller ones. Auctions often create unhealthy price levels while small PE groups can often buy companies directly," Torsten Krumm, partner at medium-sized German private equity group Odewal, told Reuters.
David Zalaznick, founder and CEO of JZ Capital Partners, a listed private equity firm which invests in U.S. and European small companies, said bigger deals tend to go for higher multiples, "so you have to leverage them more which increases the risk, or over-equitize them which reduces the returns".
"We like small and medium-sized companies because you can buy them at lower multiples, they are easier to grow, they are usually private and often you can buy them away from an auction process," he said.
In Europe, almost 40 percent of the capital raised to fund European buyouts flows into the mid-market, with almost a quarter of all deals involving mid-market firms, says the EVCA.
Andrea Bonomi at InvestIndustrial said Europe was the region to target as far as mid-market funds were concerned because of the "attractive valuations that are available and the potential for GPs (general partners) to make a significant difference to their investees' performance by helping them to globalise".
The big buyout funds say that, just because they are big, it does not mean they only do big deals, especially in an environment where the size of a "large" deal is shrinking.
The head of European private equity at Blackstone said at an industry gathering in Berlin last month that the firm was open to doing deals whatever the size.
Investors in private equity firms believe that while some medium sized groups may have performed well over the shorter term, the big players have "justified their position" over a 20 year period, Peter Pereira Gray at The Wellcome Trust said in Berlin.
Another argument in favour of investing in bigger private equity firms is that they offer scale that big institutions are looking for given the size of the funds they need to invest.
"You can't look at the IRR as the only measure. The quantitative dollars that you can deploy in these large funds is a factor that should be considered as well," David Rubenstein of buy-out giant Carlyle told the Berlin conference.
"These larger funds - and they do do smaller deals - they do have the ballast of pretty high qualified people, they're not likely to break apart, they do get the best managers, the best deals from Wall Street, the best financing teams so they do have a lot of advantages." he said.