Out of the frying pan and into the fire

The UK middle market has thrived on a wave of secondary buyouts in recent years, while sceptics have queried whether the game of pass the parcel made for a sustainable private equity model.

Now the latest research shows the industry may have to think again as the supply of secondary deals tightens and look elsewhere for deal flow.

Close Brothers, an independent corporate finance house, says an imminent scarcity of secondary transaction targets threatens and it will push firms to look to do more public to privates.

Secondary deals used to be seen as the poor relation to prime origination. However, our research shows that they are the core type of private equity transaction. Mark Barrow, head of private equity coverage, Close Brothers

According to the firm one of the key sources of deal flow to date in 2006 has been secondary buyouts – accounting for over 50 percent of deals in the €50 million to €500 million range – up from 25 percent in 2002.  In contrast, in the UK alone, traditional buyouts from corporates fell, from 50 percent  of the market value in 2000, to only 13 percent in 2005.

Mark Barrow, head of Close’s private equity coverage group said: “Secondary deals used to be seen as the poor relation to prime origination. However, our research shows that they are the core type of private equity transaction. This shift has been forced by the weight of capital allocated to private equity.”

Recent Close Brothers research of UK mid-market private equity truly demonstrates the consequences of today’s immature portfolios. It shows that today, the average amount of time that private equity groups have held companies in their current portfolios is only 2.3 years.

Based on a typical holding period of a portfolio company being three to five years, Close Brothers predicts a significant shortfall in secondary buyout opportunities in the UK over the next eighteen months.

Barrow said: “It is a very noticeable trend that portfolio cupboards are looking quite bare and that we’re about to witness a dearth of secondary buy-out opportunities.  This will force private equity groups to look elsewhere to source deals.”

Barrow: PE keen to take public companies private

One alternative transaction type that private equity groups are expected to focus on is public-to-private deals, according to Close Brothers. In 2005 there were 35 public-to-private transactions across Europe valued at €31 billion. In the first half of 2006 alone there have been 10 public-to-privates valued at €23 billion.

Barrow said: “Private equity groups are now keener than ever to take public companies private, whilst shareholders of these companies are playing hard to get.  But every company has its price. Shareholders should consider that we are currently reaching the end of a bull market and when share prices really start sliding, as they are expected to do in 2007, they might end up regretting not accepting the prices now on the table.”

But unless markets do begin to slide, public-to-private deals may prove just as elusive or just plain expensive.