Passing the baton

The rising number of recent deals where private equity firms are both vendor and acquirer could potentially antagonise investors who effectively have their capital invested in the same asset across multiple funds.

Sponsor-to-sponsor deals, also known as secondary buyouts (and less flatteringly a practice referred to as “pass the parcel”), accounted for 45 percent of total European buyout value in 2010, up from an average of 39 percent in the years between 2004 and 2007, according to Bain & Company’s Global Private Equity Report 2011.

There are numerous recent examples. In March, for example, Duke Street Capital took restaurant chain wagamama off rival Lion Capital’s hands for £215 million giving the Japanese chain its third set of private equity owners. In April, Apax Partners bought Activant from buyout peers Hellman & Friedman, Thoma Bravo, and JMI Equity and Sagard sold its stake in Kiloutou to French peer PAI Partners for a 6x return.

Secondary buyouts make most sense when they are passing a company up the food chain

David Currie

The proliferation of sponsor-to-sponsor activity was “one unambiguous bright spot in the 2010 PE-exit market” given it accounted for 25 percent of the sale values globally, according to Bain’s report.
Yet the trend risks alienating investors. An oft-expressed complaint from LPs is that they can be exposed to two sets of transaction fees, and two sets of carried interest payments, if they are committed to both the seller’s and the buyer’s funds.

David Currie, chief executive of fund of funds SL Capital Partners, said warning bells ring when secondary buyouts dominate a fund’s deal pipeline. “That brings into question their ability to originate deals and suggests they may get most of their deal flow from investment banks.”

Bain cited an institutional investor in its report who was similarly concerned about what the trend indicated: “We scratch our heads when a company is passed between two large firms with similar characteristics and skill sets. What performance improvements will the new owners be able to make to the company that the previous owners already haven’t made?”

Currie said: “Secondary buyouts make most sense when they are passing a company up the food chain. It allows private equity to continue to support the company's growth to the point when it can be listed or sold to a trade buyer and there have been many examples where each GP has made a good return on his investment.”

 Data suggest sponsor-to-sponsors tend to deliver. A study by Golding Capital Partners and the Centre for Entrepreneurial and Financial Studies at the Technische Universität München found the median IRR of secondary buyouts examined was 32 percent compared with 38 percent for primaries. The marginally lower figure for secondary deals was attributed to their generally larger size, with big deals generally delivering smaller returns.