Secondary buyouts produce returns that match or even exceed returns on primary buyouts sold to private equity acquirers, while carrying substantially less risk, according to a report by The Boston Consulting Group (BCG) and HHL Leipzig Graduate School of Management.
The findings of the report, titled: "Take a Second Look at Secondaries: Owners That Raise Their Value-Creation Game Can Excel," are a strong challenge to critics who claim that secondaries – companies whose ownership passes from one PE buyer to another – are second-rate assets because they have little potential for value creation.
Drawing on one of the largest samples of primary and secondary buyout transactions ever compiled, the report reveals that the median annual return on the secondaries in the database was 24 per cent, compared with 20 per cent on primaries sold to PE acquirers.
Another key finding suggests strongly that merger and acquisition (M&A) activity, not leverage, is the surest route to improved returns on secondaries. The median annual return on secondaries that did add-on M&A was 25 per cent, compared with a median return of 15 per cent on those that did not.
"The competitive returns of secondaries that engaged in add-on dealmaking were driven by the synergies and operational improvements that the deals generated," says Jens Kengelbach (pictured), a BCG partner and co-author of the report. "So it is puzzling that less than 30 per cent of secondaries in our sample engaged in M&A – even though private-equity executives generally regard M&A as their primary value-creation lever, ahead of alternatives like geographic expansion and outsourcing."
Many PE professionals regard tertiary buyouts as the exit of last resort – to be engaged in only if the market’s IPO window is closed or strategic buyers show little interest in the asset. But the evidence does not support this view. Returns on secondaries sold to a tertiary buyer were within striking distance of the returns on trade sales. The median annual return on the tertiaries was 21.5 per cent, compared with 25.8 per cent on the trade sales.
Secondaries that were exited through a sale to a tertiary buyer also held up well compared with those exited through a trade sale on operational-performance metrics such as sales and earnings growth. With little evidence that the IPO market will revive in the near future, investors in secondaries should know that tertiaries remain a viable option.
Secondary buyouts have become an increasingly prominent feature of the PE landscape. Secondary and later-stage deal volume in the first nine months of 2012 was roughly USD56bn, according to statistics compiled by Preqin, a clearinghouse for information on alternative investments. Activity in secondary and later-stage transactions is likely to remain high for the foreseeable future, owing to steep declines in public-to-private deals, the moribund state of the market for initial public offerings, continuing efforts by PE firms to deploy capital accumulated during the buyout boom, and pressure from investors for the return of some of their funds.
