Origination: Carve-outs and take-privates

Over the past few years, carve-outs have proved their worth as a solid deal source for the private equity community. According to unquote" data, the route has provided the industry with a steady 40-60 buyout transactions every six months since 2010 and looks set to remain just as reliable in 2015, with 43 deals already inked as of early September.

"When we look at our statistics, we see that the volume of carve-out deals has been fairly stable over the past decade," says Hein Marais, a partner at PwC. In the years that followed the credit crunch, carve-outs were one of the few M&A segments to stay strong, he says. Liquidity-seeking corporates were keen on downsizing, but the post-crisis subdued market did not have the capacity to absorb the large assets up for sale. Instead, it became necessary to break divisions into smaller, more manageable chunks causing an uptick in spin-offs.

"Since then, the size of the companies being spun out has gone up and that is the main change," says Marais. "According to our data, the value of carve-outs has gone from representing 20% of all M&A activity after the credit crunch to 40% today."

Comeback kid
Even if carve-outs look set for a comeback, the challenges associated with them have not gone away, including parent separation and transitional costs, regulatory hurdles and a time-consuming process. Not surprisingly, spin-offs are twice as likely not to complete compared to standard transactions; parents are three-and-a-half times more likely to pull back from an exit than other sellers, according to PwC. A way for private equity to win over a reluctant vendor is to play on the natural strengths it has over corporate buyers. Says Marais: "Unlike corporates, private equity funds don't need to consider how the division will integrate within their structure. The industry is inventive and doesn't shy away from the complexity of these deals."

Over the past few years, imaginative private-equity-backed carve-out schemes have sprung up across the landscape. Big pharma, for instance, has witnessed product lines being metamorphosed into federated entities, with GPs setting up a virtual management hub as they outsource research, logistics and sales functions.

Healthcare aside, sectors that have witnessed large levels of spin-off activity include retail, consumer goods and, in particular, post-bailout financial services. "And we expect the appetite to grow," says Marais. "GPs require portfolio companies to improve performance greatly if they want a strong multiple and the growth potential of business units is considerable as they're often not given the focus they need under a parent."

Return of the risky take-privates
While carve-outs look set to remain a deal-sourcing staple, take-privates have seen their popularity dwindle, with fewer than 10 transactions per half year since 2010, a far cry from the 23 de-listings reported by unquote" in 2007. "There has recently been a slow rise in public-to-private deals," says Simon Boadle, a corporate finance partner at PwC. "But rather than a return to pre-crisis levels, it is a return to normal market conditions after years of market volatility and uncertainty around valuations."

While he expects public-to-private deals to continue their upward trajectory, Boadle notes this route is not private equity's favourite source of dealflow: "When you agree a transaction with a private company, there is usually very little completion risk. Public offers are far less certain – there are negotiations with the target board and key shareholders, market pricing uncertainty and competing bidders who can come in and counter-bid."

In countries like the UK, this has been compounded by the Takeover Code, introduced in 2011, whereby bidding companies are now forced to produce a firm offer for a listed asset within 28 days of being identified as a potential suitor.

High stakes
Polaris Private Equity has been the latest player to discover the throw-of-the-dice nature of take-privates. In August, the Danish firm put forward a bid to take over 76.18% of listed ferry operator Mols Linien from bank Nykredit, government-backed fund Finansiel Stabilitet and corporate Clipper Group. Although Polaris's offer was accepted by the three owners, its plans to de-list the business raised objections among some individual shareholders. The dissenting group then attempted to gather the 10% shares required to keep Mols public but were unsuccessful. Ultimately, Polaris was successful in its de-listing effort, with the GP accumulating 80% of the company's shares. 

In spite of the lingering risks, de-listings still have their place for those firms having found the right target and the right price, says PwC's Boadle.

Markus Golser, senior partner at Graphite Capital, describes the ideal take-private candidate as "an undervalued, historically underperforming business that is run by a good team with ambitious growth plans". Boadle subscribes to this view but highlights the challenge in unearthing mispriced assets in a public market that is efficient in rightly valuing listed companies: "Aside from looking at data and metrics for valuations, it often comes down to solid industry knowledge, to anticipating how the market and valuations will evolve in the company's sector after a take-private takes place."

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• Topics
• GPs
• Buyouts
• Origination Series
• Top story
• Polaris Private Equity
• Graphite Capital
• PwC