Not all seconds are sloppy

Industry professionals are well aware that private equity-backed businesses outperform their publicly-listed counterparts. What is not so well known is that buyouts sourced from private owners tend to benefit more from higher growth than those acquired from stockmarkets. What may surprise many cynics is that even recycled deals - buyouts from other private equity firms - outperform those sourced from public markets.

"The findings dispel the myth that private equity buys a company, cuts costs, leverages it and that's that. In fact the backers go on to create value: our survey in 2006 showed 44% of ebitda growth coming from organic revenue growth; that grew to 52% in 2007," says Simon Perry, head of private equity for Ernst & Young, which conducted the research.

This third annual survey of global exits revealed that targets sourced from other private equity firms grew enterprise value (EV) by an average of 27% per annum, compared with just 19% per annum if a buyout was a take-private.

That secondary buyouts outperform take-privates (on average) is in marked contrast to the notion that recycling deals offer less opportunity for value creation. "Building businesses and value takes time," explains Perry. "Private equity is able to take the time to deliver, but it may take two or three private equity firms instead of one." This is often down to the timing of reforms: a backer may identify 10 different objectives for a target and prioritise four. As the backer completes these and moves on to the next few, some of the first four will begin to bear fruit. It depends on the number of objectives set; how many can be done simultaneously and how quickly the results come through.

The story for growth following a public-to-private is less rosy. "There may be less opportunity to improve formerly listed companies since much of it is so systematically organised to begin with, owing to reporting requirements," Perry suggests.

The lacklustre growth following take-privates should put selling shareholders at ease since it indicates they're generating a decent premium on their asset. Alan MacKay of 3i's Quoted Private Equity backs up the notion of vendors getting a premium on share prices. He estimates that a private equity firm doing a take-private pays around 140% of the enterprise value at entry: 30% premium on the market cap plus 10% in transaction fees, and therefore subsequent growth is eroded by the initial entry price.

"It goes without saying that a 15% EV IRR in the hands of a good buyout house with well-managed leverage will convert that into 30% cash-to-cash equity IRR. So I think EV growth is interesting, but only part of the story."

German efficiency

Another surprising revelation from the study is that Germany offers the largest private equity outperformance, with private equity-backed firms experiencing EV CAGR of more than three times their listed counterparts (see graph, right). Perry speculates this is the result of a tax system and culture that promotes the passing of business from one generation to the next, rather than maximising shareholder value, as is the case in the UK.

Perhaps shockingly, the Northern Europe region (Benelux, Switzerland and Nordics) has public company performance that outshines that of private equity-backed businesses.

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