The Quest for Alpha: Understanding How the Danish Private Equity Industry Creates Value in Their Portfolio Companies

Abstract

This paper empirically examines the skill of Danish private equity funds from 2002 to 2018 by investigating whether or not they create alpha, comparing the economic value added in portfolio companies against a peer group of publicly traded companies. To do so, the study uses a dataset consisting of 317 danish companies owned by private equity funds between 2002 and 2018. The study seeks to test the value drivers' effect on EVA to understand how the private equity funds generated excess value. By developing a set of proxies predicated on the findings from the litterateur review, the effect was measured by including these as independent variables in multiple linear regression, using EVA as the dependant variable. The conclusions were backed by a series of interviews with the industry discussing the value drivers from a practical perspective. Through active ownership and flexible capital structure, the PE firms want to develop and improve the efficiency of the companies and afterwards sell them with economic profit. The study shows that the value creation of PE affiliation can be categorized into Financial engineering, Operational engineering, Governance engineering and multiple expansion. The paper employs the performance measure of Economic Value Added (EVA) to investigate the value creation in the portfolio companies relative to a control group of publicly-traded peers. To measure EVA, it is necessary to reformulate the financial statements, estimate the WACC and conduct a DuPont analysis of the portfolio companies and their respective peers. The findings show that during 17 years, the portfolio companies added an averagely of 24.54 million DKK of value while the control group added 18.121 million DKK, confirming that private equity affiliation adds excess economic value to their portfolio companies. The evidence suggest that the value contributed from financial engineering is not taking place inside the portfolio companies, thus mainly effecting the return on investments via gearing in the holding company. Finally, the results indicates that the skill level varies between the different funds and that operational engineering is the main value driver, as private equity affiliated firms are able to generate excess return from operations.