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secondary buyouts
Secondary buyouts:
The industry’s black sheep?
Secondary buyouts have often come under fire, accused of offering poor returns
for LPs. But new research suggests secondary returns can match those seen in
primary buyouts. John Bakie investigates
The practice of buying portfolio companies from other financial
owners has often been criticised for representing a bad deal for
funds’ investors. Many argue that by acquiring a firm from
another private equity house, there is little chance of making a
substantial return, as the previous investor will have exhausted
any available value-enhancing measures.
Though secondary buyouts had been considered an undesirable
route for both buyers and sellers, intense criticism really began
when the financial crisis first hit in late 2007. As economic
conditions deteriorated, so too did the appetite of many trade
buyers and public market investors, and more private equity
funds sought to sell their portfolio companies to their peers.
The increase in secondary buyouts raised significant questions
over how profitable they could be.
However, research from Munich-based fund-of-funds Golding
Capital Partners suggests secondary purchases have, on average,
nearly the same value-creating potential as primary buyouts.
The fund-of-funds manager used data on portfolio companies,
gathered as part of its due diligence process, to analyse the
returns produced by secondary buyouts. It found the median
IRR for a secondary buyout is 31.9%, compared to 37.9% for
primary transactions. Returns achieved were more likely to be
affected by other factors, such as timing, deal size and region,
rather than whether or not they were secondary transactions,
according to Golding.
“In the past there was always a question about the attractiveness
of secondary buyouts,” says Jeremy Golding, managing director
of Golding Capital Partners. “This study provides empirical
proof that for private equity funds, secondary transactions are
just like primary buyouts. Fundamental opposition to buying
companies from private equity funds is clearly not justified.”
The secondary buyouts studied by Golding not only produced
reasonable returns for investors; they were beneficial for the
portfolio companies. Operational value creation showed little
difference between primary and secondary deals, with similar
increases to both EBITDA and free cashflow. Similarly, firms
did not require an increased use of leverage to boost returns.
Secondary buyouts do use slightly more leverage on average
than primary deals, but the difference (1.9:1 for primaries;
2.1:1 for secondaries) is insignificant, according to Golding.
There is no doubt the debate over whether secondary buyouts
offer a good deal for LPs will rage on, and in some cases LPs’
concerns will be justifiable. However, Golding’s research
suggests that much of the criticism levelled at secondary
buyouts as a whole may be unwarranted.
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