Study defends ‘pass-the-parcel’ deals

In a year in which secondary buyouts have dominated, research from Golding Capital Partners shows ‘fundamental opposition to buying companies from private equity funds is clearly not justified’.

Secondary buyouts have historically generated only marginally lower returns than primary buyouts, according to research from German fund of funds Golding Capital Partners.

Referred to as “pass-the-parcel” deals because they involve assets being passed from one financial sponsor to another, the transactions have drawn criticism from limited partners and other market participants who argue the deals are often  struck at high prices and provide little scope for further value creation. In some instances LPs will find themselves indirectly owning the same asset, which has been passed between two of its GPs with all the associated transaction costs.

The study provides empirical proof that for private equity funds, secondary transactions are just as attractive as primary buyouts.

Jeremy Golding

An analysis of 286 realised transactions from Golding’s deal database conducted with academics from the Technische Universtät Mücnhen revealed that secondary buyouts had generated a median IRR of 31.9 percent, compared with 37.9 percent generated by primary investments.

The difference in returns  can largely be put down to the fact that secondary deals are on average larger in size than primary buyouts, and returns are inversely correlated to deal size, said the report.

The study also concluded there is “little difference” in the levers for operational value creation between primary and secondary transactions.

“Fundamental opposition to buying companies from private equity funds is clearly not justified,” said Jeremy Golding, managing director of Golding Capital Partners, in a statement. “In the past there was always a question mark about the attractiveness of secondary buyouts. The study provides empirical proof that for private equity funds, secondary transactions are just as attractive as primary buyouts.”

LPs will be particularly interested in the study, given the prevalence of secondary buyouts this year. Private equity funds have in many cases been the most motivated buyers and sellers of companies throughout the downturn.

In the first nine months of 2010 in the UK, for example, secondary buyouts accounted for nearly half (44 percent) of total buyout activity, with firms trading £5.5 billion-worth of investments between themselves, according to the Centre for Management Buy-out Research.