Secondary Buyouts?

Was just reading this article (http://finance.fortune.cnn.com/2014/04/28/private-equity-exits/) about the stock of private equity backed companies that should be nearing maturity from a holding perspective for financial sponsors.

What caught my eye (aside from the data) was the mention of secondary buyouts, or sponsor to sponsor transactions. As a new professional to the arena, it would strike me as less-than-optimal way to monetize your investment - having highly sophisticated financial buyers and sellers on both sides seems like a zero sum game of sorts. In the absence of revenue/cost synergies how does the next financial buyer create value? Does it just mean that the selling sponsor is leaving something on the table? Or is there enough variation/differentiation in strategies across firms to make it work?

Anyways, just looking for any perspectives insiders have on how to think about this.

 

My take on it:

  • if the hold period is getting too long and no strategics are looking but a sponsor is willing to take it off your hands (so basically leaving something on the table, but is a a 3.0x return worth it over a 2.5x if it'll take an additional 3-5+ years to realize?)
  • smaller sponsor selling to a larger sponsor with more resources/experience in managing a bigger company
 

So I get why a sponsor would sell to another sponsor - just the highest bidder most of the time. But if another sponsor is theoretically interested in your property, wouldn't that also suggest that the original seller is still leaving some gains on the table (understanding that there are time tradeoffs between greater cash returns and IRR)? Or that the buying sponsor is overestimating the return potential? If I was the selling sponsor and I could see 20%+ annual returns clearly for additional time into the future, I'd probably be willing to take that risk (given that your carry stake would be larger, though farther away).

I guess, stated differently, if you're a sponsor that is attempting to invest in another sponsor-backed company, how do you go to your IC and say "the seller is highly sophisticated, had 20%+ hurdle rates just like us, probably squeezed every last penny out of it, and is good at the timing the market, but we still think we can hit our returns."?

My list so far would include: - Seller specific reasons (need to close out fund, partnership shutting down, etc.) - Need to "trade up" sponsonr for portfolio co if it outgrew their area of expertise - Maximizing time/cash on cash return/IRR - Alternative strategy or strengths of buyer - Buyer is willing to accept lower returns

 

From the seller's perspective: Funds have time horizons, even if there are returns left to be realized in the future, distributions are part of the PE life cycle. There is a reason why the investment team chose a specific point in the cycle to pursue an exit, and another PE firm submitted the highest bid.

From the buyers' perspective: Recall that cost reductions / synergies are only one way to generate returns. A company throwing off heavy cash flows can be attractive from and Equity IRR perspective via leverage. As for the optics of having a sponsor on the other side of the transaction, one can argue that the need for distributions makes them a motivated seller. Perhaps the cycle timing prohibited the previous sponsor from exiting at peak multiples, leaving money on the table.

GPs are heavily incentivized to achieve above-hurdle returns. Forget about justifying a purchase to the LPs; why would the GP be pursuing the transaction if it weren't confident in the return profile?

Such is the catallaxy of markets; variant views are the catalysts for transactions. This question is silly; akin to asking why anyone would buy a home or a car or public equity - after all, the seller must think he's getting a good deal!

"For all the tribulations in our lives, for all the troubles that remain in the world, the decline of violence is an accomplishment we can savor, and an impetus to cherish the forces of civilization and enlightenment that made it possible."
 

@"NorthSider" I'm not concerned by the optics of it and I'm not particularly swayed by the argument "it happened, so therefore it must have been right." I also don't think it's a silly question - in fact large portions of economics study this exact question (capturing surplus in a transaction). Though I agree - "variant views are the catalysts for transactions", but what drives those variant views/situations most of the time? Seller-specific needs? Differing strategies? And do they bear fruit?

I guess I was looking for any PE monkeys out there who could say with some degree of certainty that they succeeded in buying from another sponsor by doing xyz, whether that means changing strategy, doing something different, or just keeping up the status quo.

Perhaps it's a purely academic question, but given the stock of investments that will need to be realized in the next few years, PE firms will probably be filtering through plenty of sponsor-backed companies. If the hypothesis that they can't create additional value (or hit their returns) when buying from another sponsor proves true, then that says something about how the private equity model is practiced (in my mind at least).

 

remember that returns are part of it, but stable cash flows are incredibly important.. the sophistication of sponsors on both ends might mitigate a sponsor's ability to get a price better than fair market value (like if they were to buy a private/family owned company looking to diversify person wealth for example), but a near guarantee of strong stable cash flows means that they might be willing to settle for slightly lower returns.

“Success means having the courage, the determination, and the will to become the person you believe you were meant to be”
 

remember that returns are part of it, but stable cash flows are incredibly important.. the sophistication of sponsors on both ends might mitigate a sponsor's ability to get a price better than fair market value (like if they were to buy a private/family owned company looking to diversify person wealth for example), but a near guarantee of strong stable cash flows means that they might be willing to settle for slightly lower returns.

“Success means having the courage, the determination, and the will to become the person you believe you were meant to be”
 
Capitol86:
I'm not particularly swayed by the argument "it happened, so therefore it must have been right."

But you are persuaded by your own insistence that two sophisticated buyers cannot trade an asset without one party being swindled? I'm much more inclined to believe that the dozens of investment professionals - having completed months of diligence, management meetings, financial audits and valuation using private information - arrived at a reasonable valuation than I am to believe that you have just discovered the scandalous flaw in private equity deals.

I also don't think it's a silly question - in fact large portions of economics study this exact question (capturing surplus in a transaction). Though I agree - "variant views are the catalysts for transactions", but what drives those variant views/situations most of the time? Seller-specific needs? Differing strategies? And do they bear fruit?

It is a silly question, especially since you seem intent on arriving at some uni-factor model for PE decision making. The proposed question, viz., "Why do two individuals hold different valuations for the same asset?", is way too broad for anyone to give you a meaningful answer. All of your rhetorical suggestions (questions?) above are reasonable explanations, but every circumstance is different.

It is especially silly since the ultimate determination of whose valuation is "correct" is the catallactic process of other individuals holding different valuations for the same asset, viz., the products of the target company. Why are you not equally mystified by the fact that the target company's customers assess the value of its products than the company itself does?

I guess I was looking for any PE monkeys out there who could say with some degree of certainty that they succeeded in buying from another sponsor by doing xyz, whether that means changing strategy, doing something different, or just keeping up the status quo.

You are looking for a degree of simplicity that simply doesn't exist. There is no "xyz". Funds do not approach an investment and say, "Oh, this company is owned by another sponsor? All right, apply the xyz valuation method, as opposed to our standard model." Different funds have different outlooks on the same market, may judge cycle timing differently, may have different feelings about management, etc. Remember also that PE fund can achieve acceptable returns without meaningful growth, so long as the company throws off enough cash to service debt.

Why do you think PE firms buy companies at a premium to trading values? Or at a high enough premium to entice a strategic to dispose of the target assets?

Perhaps it's a purely academic question, but given the stock of investments that will need to be realized in the next few years, PE firms will probably be filtering through plenty of sponsor-backed companies. If the hypothesis that they can't create additional value (or hit their returns) when buying from another sponsor proves true, then that says something about how the private equity model is practiced (in my mind at least).

Why do you seem to hold the view that the identity of the owner of a specific business affects its return profile? If the same business were owned by Bill Gates instead of KKR, would you suddenly be willing to pay a different price?

"For all the tribulations in our lives, for all the troubles that remain in the world, the decline of violence is an accomplishment we can savor, and an impetus to cherish the forces of civilization and enlightenment that made it possible."
 

Sigh. Killer takedown Northsider. Not really interested in a flame war here. I take it by your insistence on using the 50-cent word "catallaxic" that you spend a lot of time on this site: http://mises.org/......But, unfortunately you may have killed this discussion. I was just looking for some ruminations, anecdotes and discussion of what I think is a highly relevant question: How are purchase price, projections and, ultimately, returns affected by the nature of the buyer and seller. It's really a question of how to analyze the dynamics of a "winners curse" (or lack thereof) in LBOs. Again, despite your perception that it is a silly question, there is a serious body of research devoted to this very issue. See for instance:

1) http://papers.ssrn.com/sol3/papers.cfm?abstract_id=2329202 - "Consistent with this agency hypothesis, we find that SBOs [secondary buyouts] made late in a fund’s investment period underperform similar primary buyouts. After a fund invests in late SBOs, investors appear to shun the follow-on fund. Early SBOs, however, have similar performance as other buyouts and some SBOs appear to be value-enhancing"

2) https://blogs.law.harvard.edu/corpgov/2014/01/11/the-performance-of-sec… - "We find that SBOs generate much lower average returns for buyers than comparable PBOs [primary buyouts]. The average SBO distributes $0.4 less cash per $1 of cash invested and has an approximately 15% lower Internal Rate of Return (IRR). These results hold irrespective of the control variables we use, including time, country, industry, and private equity firm fixed effects."

and

"The underperformance of such a large and fast-growing class of private equity investments is a puzzle. We analyze three potential explanations, which are not mutually exclusive: (1) agency problems between private equity funds’ managers and investors generate an incentive to overpay for SBOs; (2) SBOs are less risky; and (3) significant value has already been extracted by the selling fund. Our evidence is most consistent with explanation (1). "

3) http://bit.ly/1lHUU6B - " In sum, it is evident that SBOs are an important, yet controversial phenomenon. Several authors (Cumming et al., 2007; Wright and Amess, 2009) identify SBOs as one of the most promising research areas in the field of private equity; however, academically we know very little about this phenomenon"

So it's not really my "insistence" on anything, it was more of an exploration of a hypothesis, of which the evidence appears somewhat inconclusive. But this academic research is so DRY. Was just looking for some color. And if secondary buyouts do generate lower returns (for whatever reasons), then as an investor, I would prefer to know what drives success/failure and avoid situations that lead to poor outcomes. But that's just me.

 
Best Response

I won't get involved in the pissing contest above, but here's a real life example: I worked at a mid market fund about 10 years ago (actually more now that I realize that it's 2014) and we acquired a boring industrial as a platform to roll up a few other companies and carve outs we knew were out there. It was early in that fund's life and we were still coming off of the dot com stock market crash and 9/11 so valuations were low, especially in the industrial space. We were able to buy the platform at a really good price and, unlike the 07-08 crash leverage was still readily available and we were ramping up into the hot and heavy debt days of 05-06, we leveraged the tits out of it and the subsequent 5 companies we rolled up into it. We were able to achieve operational efficiencies in the roll up and valuations increased in the 2-3 years we held it so we (I wasn't that high up at that point so it was more like the partners) decided to exit. We hadn't even hit the end of our investment period but we could make our LP's happy with a big exit and hurdles just keep building as the years go on for called capital (I don't know where you're getting 20%/annum), so we put it up for sale and another sponsor bought it. Could we have held it for longer and made more in absolute dollars, yes, but we did very well on it in a short timeframe, it made our LP's happy, and it put dollars in our pockets (some of which we had to reserve for clawbacks). We didn't care who bought it and our bankers put it out to everyone but other funds had just raised even more money than us and needed to deploy it so a financial sponsor ended up the winner on price and terms (a strategic bid more dollars but it wasn't all cash, it consisted of restricted stock and paper). We saw the value in realizing profit, they saw the value in the asset and needed to deploy capital, and we rolled up the companies and built it into a size that hit this fund's wheelhouse.

 

Porro ipsum iste dolorem omnis eius. Qui consectetur quisquam eligendi adipisci aperiam id. Cumque deleniti accusamus magnam error consequatur culpa dolore. Et quia doloribus sit fuga eum iure quam. Iure dicta nisi aut assumenda aut asperiores.

Est quia et asperiores ducimus. Tempora veritatis et quasi est nemo quae. Et dolor minima in optio architecto. Et eos quisquam dolores quisquam error voluptatem. Qui dolorem deserunt nobis voluptatem dolorum quod asperiores. Assumenda maiores quaerat in et. Non aut alias doloremque reiciendis qui.

Life, liberty and the pursuit of Starwood Points

Career Advancement Opportunities

March 2024 Private Equity

  • The Riverside Company 99.5%
  • Warburg Pincus 99.0%
  • Blackstone Group 98.4%
  • KKR (Kohlberg Kravis Roberts) 97.9%
  • Bain Capital 97.4%

Overall Employee Satisfaction

March 2024 Private Equity

  • The Riverside Company 99.5%
  • Blackstone Group 98.9%
  • KKR (Kohlberg Kravis Roberts) 98.4%
  • Ardian 97.9%
  • Bain Capital 97.4%

Professional Growth Opportunities

March 2024 Private Equity

  • The Riverside Company 99.5%
  • Bain Capital 99.0%
  • Blackstone Group 98.4%
  • Warburg Pincus 97.9%
  • Starwood Capital Group 97.4%

Total Avg Compensation

March 2024 Private Equity

  • Principal (9) $653
  • Director/MD (21) $586
  • Vice President (92) $362
  • 3rd+ Year Associate (89) $280
  • 2nd Year Associate (204) $268
  • 1st Year Associate (386) $229
  • 3rd+ Year Analyst (28) $157
  • 2nd Year Analyst (83) $134
  • 1st Year Analyst (246) $122
  • Intern/Summer Associate (32) $82
  • Intern/Summer Analyst (313) $59
notes
16 IB Interviews Notes

“... there’s no excuse to not take advantage of the resources out there available to you. Best value for your $ are the...”

Leaderboard

1
redever's picture
redever
99.2
2
Secyh62's picture
Secyh62
99.0
3
Betsy Massar's picture
Betsy Massar
99.0
4
BankonBanking's picture
BankonBanking
99.0
5
dosk17's picture
dosk17
98.9
6
DrApeman's picture
DrApeman
98.9
7
kanon's picture
kanon
98.9
8
CompBanker's picture
CompBanker
98.9
9
GameTheory's picture
GameTheory
98.9
10
Jamoldo's picture
Jamoldo
98.8
success
From 10 rejections to 1 dream investment banking internship

“... I believe it was the single biggest reason why I ended up with an offer...”