Current Private Market Valuations

In the private markets world, one overriding refrain was a hallmark of 2022: Valuations are bogus. The topic dominated nearly every meeting, every conversation. How can public markets be down 20% and private markets only be down something like 5%? Well, let us start with the punch line.

Valuations are pretty accurate across most private market sectors.

Oof, that was no doubt a disappointing conclusion to what you thought might be an exposé blowing the roof off those fake private numbers…. Suspend disbelief momentarily and we’ll share why there are some reasonable explanations for the better performance of private markets relative to their public peers.

Sector Composition

Let’s start with an interesting fact. More than 30% of the component companies of the S&P 500 had positive returns in 2022. Twenty percent were up more than 10%. So get rid of this notion that everything went down last year. Selection certainly mattered, and sectors mattered a great deal. Would you rather have been in industrials or information technology? Now look at top- and bottom-quartile numbers for private equity managers.

Selection mattered a great deal here. The top quartile saw less information technology and more industrials and consumer staples. But you can see that, overall, better-performing sectors have a greater weighting, generally, in private portfolios and poorer-performing sectors have smaller weightings than in public indexes.

Those who prefer anecdote over data may not believe it, but private companies performed better than their public counterparts in 2022.

Here’s a fun fact: Nearly 40% of companies in the Russell 2000 index have negative earnings. Not earnings growth, just negative earnings. Only 8% of private companies had negative EBITDA through Q3 2022.

We’ve long argued that private equity outperforms because it’s a better form of governance than public ownership. We’ve made this point over and over. We don’t believe that private equity outperforms because it uses more leverage. Leverage helps, sure, but it’s by no means the driver. Private ownership means more control, greater alignment, a shared focus on the same goal. Proof of this concept would be better operational performance, and that’s exactly what we see in the 2022 year-to-date numbers.

Operational Performance

Let’s look at it across sectors. You can see that in most cases, private market valuations began the year at a significant discount to comparable traded assets. Communication services is the glaring exception, but we believe that’s driven by differences in composition at the sub-sector level. The large telecoms that trade publicly are fundamentally different businesses than the high-growth digital media companies that compose the private sample. That meant there was room for public equity valuations to fall without the same decline for private equity. And that’s what we saw: Valuation multiples for public equities and private equities converged over the course of 2022. We do not see any blanket over or under valuation from a multiple perspective in the private equity numbers.

Transaction Comps

Last year we showed that entry multiples in public markets had never been higher than those in private markets. That implied that any valuation adjustments in public markets had some room to decrease before those declines were reflected in private marks. If the public market valued my company sector at 20x and I bought it at 15x and the public market multiple went down 20% to 16x, my company at 15x isn’t going to decline 20% because it’s still at a discount to the public comparable.

Exits in 2022 were still above valuations. That would tell you that the valuations can’t be disassociated from reality. Hey, look, here’s more data on the matter!

Again, exits are occurring with strong multiples even during a period when public markets are declining 20%. There may be one or two irrational buyers out there, but there aren’t as many as there are exits at strong valuations on the private side. We acknowledge the likelihood that the exits are happening for the better-performing companies, but the point here isn’t that every company is precisely valued in every portfolio. The point is that, in aggregate, valuations accurately reflect what’s happening in portfolios at this time.

Exits as Evidence of Valuation

The real proof of whether valuations are accurate is whether you exit a portfolio company at the value you show for it. You have heard us cite the statistic that exits tend to occur at prices higher than valuations. No, we didn’t make that up.

You can argue that a portion of this period is during a strong public market, but the last three quarters were during the bear market of 2022.

MEDIAN TVPI AT EXIT

BY EXIT YEAR

What’s Next for Valuations

Count us as firmly in the camp that the data and analysis debunks the valuation myth; yet, we know that some of you remain unconvinced. After all, we’ve all read the pundits stating, almost as a matter of fact, that private market valuations are coming down.