Secondary buyouts drive strong returns

Secondary buyouts – when a company passes from one private equity firm to another – have produced returns as good as, or at times superior to, primary acquisitions, according to new research from Boston Consulting Group. And the secondary deals come with less risk, the study said.

Conducted in partnership with HHL Leipzip Graduate School of Management, the study draws on a sample of returns from 225 private equity holdings. The report shows the median annual return on secondary transactions in the database was 24 percent, compared with 20 percent on primaries sold to private equity buyers.

Further, the median return on secondary deals that completed add-on M&A activity, and not leverage, was 25 percent, compared to 15 percent on those that did not, according to the study.

“The competitive returns of secondaries that engaged in add-on dealmaking were driven by the synergies and operational improvements that the deals generated,” said Jens Kengelbach, a BCG partner and co-author of the report.

The findings appear to contrast a perception among some limited partners that secondary buyouts are simply a “recycling” of worn portfolio companies from one firm to another; a possible sign that no other exit option was available, or that no other deals could be found.

During the past few years, horror stories of businesses going bust after being owned by private equity firms have dominated the media. One prime example was Simmons Bedding, which was traded over a number of years by firms like Wesray Capital, Merrill Lynch Capital Partners, Investcorp, Fenway Partners and Thomas H. Lee Partners, before going bankrupt in 2009.

However, GPs that look for secondary buyout opportunities generally look for angles that previous private equity owners have not pursued, Kengelbach said in an interview with Private Equity International Thursday.

So a first owner might be involved in operational improvements, while a second owner would look for opportunities to buy and build – say expand internationally, Kengelbach said.

“The interesting thing is our clients don’t buy if they don’t find an angle completely different from what the first guy did … it can be an international expansion, an add-on creating depth and scope, changing the operational model, Kengelbach said.

The findings are good news for the industry because secondary buyouts have become “increasingly prominent”, the study said. Secondary and later-stage deal volume in the first nine months of 2012 was roughly $56 billion, according to data provider Preqin.

Secondary deal activity is likely to remain strong because of declines in public to private deals and the stagnant state of the IPO market, as well as continued efforts by private equity funds to deploy capital and return distributions to LPs, the study said.