UK secondary buyouts on the rise

Deep pockets and some strategic advantages often allow private equity managers to outbid trade buyers, according to new research.

That IPOs have been thin on the ground recently isn’t news. Private equity investors looking to exit their investments are heavily relying on trade sales as well as secondary buyouts. New statistics for the UK excluding receiverships suggest that, favoured by current market conditions, the latter have come to play an ever more important role.

According to Zephus Corporate Finance Knowledge, trade sales accounted for 125 of the 199 UK buyout and venture capital transactions that were exited during the year ending 31 May 2001. 50 investments were exited via secondary buyouts, and 24 led to a stock market flotation.

A look at the same data in terms of deal value shows that £4.7bn worth of private equity backed companies were sold to trade purchasers, £3.8bn to financial buyers and £1.2bn to stock market investors. From the point of view of secondaries, this compares favourably with the year ending 31 May 2000 when trade sales accounted for £6.6bn worth of exits, secondaries for £2.5bn and IPOs for £1.5bn.

“The secondary buyout market has become more significant to private equity investors”, says Michael Folkman of Zephus. “The evidence isn’t conclusive, but auctions as well as current conditions in the public market mean that when it comes to price financial purchasers can now compete with trade buyers on par. “

The downturn in the equity market has made it harder for public companies to fund acquisitions using their share capital. Many private equity funds, by contrast, are cash rich.

Other weapons financial buyers use to compete with their trade rivals are well-honed negotiation skills and greater familiarity with the deal process. They also face less of a risk of being referred to competition authorities.

A further aspect allowing secondary buyers to generate value is the recent rise of buy-and-build, which has become a staple strategy for a multitude of private equity houses.

Private equity managers appear to have great confidence in their ability to make secondaries work: last year the average deal value, at £86.8m, was considerably higher than for trade sales (£58.3m).

So secondaries are in vogue, but, according to Zephus’s Folkman, this does not mean they should be thought of as a direct alternative to trade sales. His analysis shows that secondaries are most common in industry sectors that are deemed unattractive by other M&A players. Predictable, cash generative sectors such as public administration, education, healthcare, leisure and social services are now all dominated by financial investors.

An example is BC Partners' purchase of General Healthcare from for nearly £1.3bn, last year's largest secondary deal.

The question remains to what extent those betting on secondaries today will really be able to create value for their investors going forward. Sceptics say a financial investor buying assets off another is effectively taking a bet on being cleverer than their predecessor. The task for private equity is to demonstrate that there is more to secondaries than that.