Private equity activity leveled off in 2015, and industry leaders in a new study generally expect to replicate the same investment levels and priorities in 2016, according to a study by BDO USA.

Ninety-five percent of firms surveyed said they planned to close five or fewer deals within the coming year, compared with 87% of respondents in last year’s survey who said they would close no more than five deals.

In addition, respondents said they would deploy their capital more conservatively, with 93% of managers expecting to invest $250 million or less in the coming year, up from 88% in 2015.

Some 66% of firms highlighted investments in new platform deals (acquiring a company in an entirely new industry) as their chief deployment of capital, compared with 67% in 2015.

Private equity leaders are also looking at the same challenges they faced in 2015, with pricing again at the top of the list, cited by more than a third of firms surveyed.

At the same time, 64% of fund managers said gaps between buyer and seller pricing expectations were their top obstacle to closing deals, up from 48% in 2015. BDO noted that many sellers may still be trying to command high prices as they have done in recent years, despite economic realities beginning to favor buyers.

“After the successes private equity experienced in 2014, market unevenness and a sluggish deal landscape led to a plateau in 2015, Lee Duran, a partner and private equity practice leader at BDO, said in a statement.

“As we kick off 2016, fund managers are being prudent about deploying their dry powder as they wait to see how the economy continues to recover and consider industry shake-out of weaker players.”

Despite fund managers’ conservative 2016 planning, the study found that 70% of respondents still felt optimistic about the investment environment for the year ahead, up from 56% in 2015.

Forty-one percent of respondents believed that private equity raises would be a primary factor in driving deal flow, while 43% cited private company capital raises and sales.

The study’s findings were based on a survey conducted by PitchBook in the fourth quarter of some 140 senior executives at private equity firms in the U.S. and western Europe.

Valuations and Opportunities

Like last year, some two-thirds of fund managers said the technology and health care/biotech sectors were the industries most likely to experience rising valuations in 2016.

In contrast, 59% of those surveyed deemed the retail and distribution sector the most likely to see declining valuations as growth in the industry continues to stagnate and consumer confidence remains volatile.

Nearly one-third of survey participants said the manufacturing sector would generate the greatest opportunity for investment in the next 12 months, even though the U.S. manufacturing sector has suffered from lagging exports owing to a strong U.S. dollar and weak demand for durable goods.

“Manufacturers are taking advantage of current conditions to set themselves up for future success,” BDO Capital Advisors managing director Dan Shea said in the statement.

“The U.S. has a sustainable energy cost advantage thereby making U.S. manufacturers more competitive globally. As such, the appeal of the manufacturing industry for private equity investment may continue for years to come.”

The survey found fund managers polarized in their expectations for energy and natural resources companies.

Fifty-seven percent of respondents believed the industry would continue to experience decreasing valuations over the next 12 months, more than a third believed valuations would increase and 15% said natural resources and energy would offer the greatest opportunity for investment.

BDO said this disparity was likely driven by uncertainty about how natural resource and energy companies would weather the continued lower prices and fallout of weaker companies. International Investment

Despite slower deal flow in the second half of 2015, 65% of fund managers expressed a generally optimistic view of the international investment environment. However, 65% also did not anticipate increasing activity over what they were currently doing.

A minority of firms surveyed said they planned to pursue more cross-border deals this year, suggesting, the study said, that some funds may be increasingly willing to expand their geographic focus in order to find good deals.

The study found that although attitudes surrounding international investment have largely remained the same, fund managers have significantly shifted their views on where they believe opportunities lie.

Survey respondents perceived Europe as the best region for new opportunities outside North America in 2016, possibly viewing Europe as a more stable and predictable market compared with some of the uncertainty in other regions, according to the study.

Only 14% of private equity managers thought Asia would present the greatest opportunity for new investment, versus 41% in 2015. China’s perceived slowdown has raised concerns that a depreciation of wealth and investor jitters may create fewer investment opportunities in the region.

Likewise, just 14% of respondents saw Latin America, also mired in economic hardships, as a top investment opportunity, down from 45% last year.

The challenges funds face in pursuing international activity remain largely the same as in 2015. The top three listed by respondents:

  • Local resources, 31%
  • Cultural nuances, 30%  
  • Regulations affecting cross-border acquisitions, 23%

Other Findings

Fifty-seven percent of private equity leaders said they specialized in an industry or region in order to identify and successfully execute deals. They used their capital to focus on key industries and markets, especially in less traditional areas where capital may be lacking.

Fifty percent said they worked with buy-side intermediaries as a sourcing strategy, suggesting, BDO said, that private equity sponsors continued to rely on direct networking and relationships with intermediaries, such as bankers, in order to target potential investment opportunities.

A big majority of fund managers reported that they had sought add-on acquisitions (buying a company to complement an existing platform business) last year in response to current market conditions, and most planned to use this strategy in 2016.

Competition for sizable deals is fierce in the current marketplace, BDO noted, and with deal volume languishing, these tuck-in deals offer a relatively low cost and low stakes way to add value to an existing portfolio.