Secondary market to the rescue

Private equity executives today are finding that selling to their peers is their biggest exit opportunity.

That presents a classic good news/bad news situation for investors, who might hear one of their general partners crowing about a big payday while another might have overpaid.

So-called secondary buyouts — in which a private equity firm buys the portfolio company of another private equity firm — was a hot area in the first quarter, with $7 billion in transactions in 24 deals worldwide, according to London-based alternative investment research firm Preqin. That compares with $5.1 billion in 43 deals for all of 2009.

In the U.S. alone, there were 21 private equity-to-private equity deals in the first quarter and by May 5, seven more had already taken place, according to data prepared for Pensions & Investments by PitchBook Data Inc., a Seattle-based research firm.

“Anyone that has a company that is growing and is a good company ... should give a hard look at selling to another private equity firm,” said Ajit Nedungadi, managing director and head of the London office of private equity firm TA Associates. “They (private equity firms) are hot to trot.”

Private equity firms with large funds are “finding that they need to deploy the capital because they are running out of time” because of the typical fund life span, Mr. Nedungadi explained. And they have a lot to spend — an estimated $1.1 trillion, according to Preqin. Funds have only a set amount of time to buy companies, nurture them and then exit the investments. The economic crisis put on hold many plans to sell portfolio companies or take them public, with transaction volume not expected to increase until the end of this year or the beginning of 2011, industry executives say.

Prices are being driven up, making now a far better time to sell than it is to buy, Mr. Nedungadi said.

What's more, prices for companies are going up, in part because banks are offering debt for only the “great deals,” and “there's a scarcity of great deals,” said Antoine Drean, founder and chief executive of Triago, a global private equity placement agent and secondary adviser headquartered in Paris

Two of the largest secondary deals last quarter were in Europe: Kohlberg Kravis & Roberts' £955 million ($1.5 billion) acquisition of Pets at Home from Bridgepoint Capital LLC and Triton Partners LLC's €850 million purchase of Ambea from 3i Group.

In March, Barclays Private Equity sold Deb Group, a British company that sells skin-care products, to Charterhouse Capital Partners for £325 million.

On May 4, TA Associates announced the sale of Sophos PLC, an information technology security and data protection firm, to Apax Partners for $830 million including $300 million of debt.

TA Associates was about to take Sophos public in 2007, but the worldwide credit crisis interrupted those plans, Mr. Nedungadi said. TA Associates planned to try again this year, but this time Apax made a pre-emptive offer that TA Associates executives could not pass up.

But these secondary buyout deals present a good news/bad news situation, even for investors with well-diversified private equity portfolios, insiders say.

“This is a good argument for investing with a smaller number of general partners,” said Don Pierce, investment officer with the $5.1 billion San Bernardino County (Calif.) Employees" Retirement Association.

These deals are not that unusual, and it is one way portfolio companies are sold, in addition to initial public offerings or mergers and acquisitions, Ricardo Duran, spokesman for the $138 billion California State Teachers' Retirement System, West Sacramento, said in an e-mail response to inquiries.

Even if CalSTRS' invests in funds on both sides of the transaction, a deal still could generate additional liquidity for CalSTRS' overall portfolio, if the system owns a larger percentage of the seller fund than the buyer fund, he said.

As more of these deals begin to occur, consultants are getting calls from institutional investors asking to quantify the impact on their overall private equity portfolios, said Francie Heller, managing director at consulting firm Houlihan Lokey in Los Angeles.

She said clients are asking whether they have, for instance, double exposure to the portfolio company, she said.