Chasing the primary deal

Primary deals have long been the stuff that private equity dreams are made of: being able to identify that overlooked but promising family-owned business, buying it (preferably off-market) at an attractive multiple, and unlocking its full potential to become the kind of European champion that whets the appetite of large international trade buyers.

In reality though, scoring that type of deal consistently takes some serious skill and dedication - not to mention a healthy dose of luck. David Ascott, a partner at UK-based advisory business Grant Thornton, warns that primary sources of dealflow remain very much hit-or-miss in the current climate: "We have seen a lot of stop-start sale processes in the market recently, and the rate of attrition is definitely higher for primary transactions."

But that doesn't stop GPs from trying and some fare rather well at it. Take for instance Equistone Partners, formerly Barclays Private Equity: out of the five transactions completed by the firm across Europe so far in 2012, four have been primary buyouts, Germany's EuroAvionics being the latest example.

Primary deals now account for less than half of buyout value in Europe, as they prove increasingly difficult to source and execute.

"There is a natural tendency to focus on primary deals, as originating such transactions requires more focus, more creativity and a more proactive approach," says Equistone managing director and UK head Rob Myers. But the firm is ready to source the best available assets, whether they are sold by another GP or not, Myers adds: "Ultimately we focus on the asset and the management team, and we are able to generate strong returns in either situation."

Disregarding the type of vendor is probably for the best, since a firm looking to do primary deals exclusively had better have very patient LPs: primary opportunities have increasingly been playing hard-to-get since 2008, while SBOs have become much more prominent in the market. Transactions sourced from fellow GPs accounted for 35% of all buyouts in volume terms last year, according to unquote" data - against less than a quarter on average between 2000 and 2010.

The picture is even bleaker in value terms. Such transactions represented more than half the overall amounts invested from 2011 to date, compared to just under a third across the previous decade. In the €500m+ segment, the proportion was up to a whopping 65% last year.

Unfit for the times?
The increasingly recycled nature of private equity dealflow does not surprise Ascott: "What we've seen in the market corroborates the stats. A very important driver here remains the need to generate cash-on-cash returns for many PE firms - the other exit routes are more difficult to explore: PE-backed IPOs are pretty much a non-starter at the moment, and sizeable acquisitions remain a bold move for many corporate buyers unless they really match their core activities."

On the buy-side, primary sources of dealflow all come with their own obstacles. As far as family vendors are concerned, the oft-quoted price expectation gap is still a fixture of the market, especially when it comes to small- and lower mid-cap businesses. "You could argue that from 2002 to the beginning of 2008, the M&A market became increasingly buoyant and vendors' expectations steadily increased in parallel, with 2008 marking a high point in that regard. The market then corrected - purchasers' expectations shifted very quickly, but this takes much longer for vendors," explains Myers.

Ascott agrees that the respective outlooks of sellers and buyers are still sometimes out of tune: "Family owners do appear reluctant to sell, and I don't think the expectations gap between buyers and vendors has narrowed that much recently. Families are still happy to keep earning cash returns from a business (especially if it has reached a certain size and is trading decently), so they are quite conservative about giving that away."

Meanwhile, corporate spin-offs appear to be on the wane as well. Some trade players streamlined their portfolios and nursed balance sheets throughout the downturn, and many of them emerged from the brunt of the crisis in reasonable shape. "When they do happen, corporate spin-offs can be hit-or-miss: quite a few have been aborted this year, notably when trading hasn't gone as well as expected," adds Ascott. Belgian mobile business BASE is the latest example: Dutch telecommunications company KPN stopped the sale process of the division in mid-August as it felt first-round bids were too far off the expected €1.6bn. Private equity suitors were said to include Blackstone, Cinven and Providence.

Better the devil you know
By comparison, SBOs come with a safety factor that is hard to overlook at a time when poor visibility on both the M&A market and a target's financial prospects is a GP's worst enemy. Says Myers: "We have very good medium- to long-term visibility on secondary opportunities. Having operated in this market segment for a long time now, it is remarkable how often we come across assets that we have already looked at in the past."

GPs getting lucky the second time around is not that uncommon: Activa Capital for instance bought French call-centres operator Armatis for a reported €200m in June, but had already scouted the business at the time of its previous buyout by CM-CIC LBO Partners in 2007.

Familiarity also has a strong impact on one of the buyout market's main drivers: an SBO could be easier to get through a lending committee - especially if the banks see that the debt on previous LBOs was always repaid on time. This is particularly noticeable in the lower mid-cap space, where regional banks already being partnered with the target company can significantly ease access to leverage. "The ‘known quantity' aspect is also important when it comes to financing," agrees Ascott. "Debt remains easier to arrange when the banks are already familiar with the asset, while they remain cautious when it comes to primary transactions." Equistone dodged the financing issue when it acquired UK-based recruitment solutions provider Fircroft in a £140m primary buyout in June: the GP is understood to have bought its stake in an all-equity deal.

Encouraging signs
Luckily for GPs eager to steer clear of "pass-the-parcel" deals, there might be some light at the end of the tunnel. Early signs point to primary transactions having made a timid comeback in the first six months of 2012, with just under a third of all European buyouts being SBOs, according to unquote" data - still some way off historical levels but a step in the right direction. Grant Thornton also saw encouraging signs in their dealflow this summer: of the 11 private equity deals the firm advised upon between mid-June and mid-August, only three ended up being SBOs.

Myers notes that this is partly down to vendors finally adjusting their expectations to a new environment: "We are now at a time when the market is reasonably stable, and vendors have had time to realise that if they want to sell their assets in the next one to five years, the current market is actually broadly supportive. We, for instance, are quite willing to offer an attractive valuation for high-quality assets."

On the sell side, unquote" has recorded an uptick in sizable trade sales in the past few months, with European PE-backed assets notably attracting the attention of large US players. The three largest exits of 2012 so far (Alliance Boots, StarBev and NDS Group exits) could be proof that large-cap GPs aren't condemned to swap assets between themselves ad nauseam.

This article is an extract from a more in-depth look at the primary market, featured in the latest issue of the unquote" analysis magazine.

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• Topics
• Buyouts
• Secondary buyout