Secondary buyouts continue to boom, but for how long?

While the European primary market for private equity is slowing down due to macroeconomic challenges, secondary transactions are booming. It seems like the perfect synergy: some investors have to deploy capital, some have to return cash to investors. The secondary private equity market should indeed be thriving from every macroeconomic hit that slows the primary market down – at least for now.

"Years ago, a secondary transaction meant that someone didn't like you," said Richard von Gusovius, principal of Campbell Lutyens, at P+P's Munich Private Equity Training (MUPET) event last week. "Times have changed; now it's day-to-day business for investor relations teams – and GPs have an appetite for it."

To date, unquote" data has recorded eight secondary buyouts in June alone, the most notable of which was EQT's €1.82bn acquisition of BSN Medical from Montagu Private Equity Partners.

Throughout Europe, the primary deal market has been significantly weakened by the debt crisis and the poor lending outlook of banks. At MUPET, Frank Thiäner of P+P explained that demand and supply of capital (meaning buyers and sellers) are not matched in the primary market at the moment. The secondary market is feeding off that.

"There is so much to buy right now. There's a lot of capital to be turned around. Every primary transaction is a secondary transaction waiting to happen," said Timothy Brody, managing director of Auda Private Equity.

But the secondary market can only be a function of the primary market. So once the backlog of bulk acquisitions from a couple of years ago runs out, the industry will have to find something new to pull itself up on.

Certainly, secondary investments can be contingent on the growth cycle of a company, moving from seed funding to venture to private equity. But when it comes to handing down assets from one GP to the next to simulate market dynamics in a downturn, there is a danger that valuations become inflated and misleading. Particularly now that many companies that were acquired during boom times have a questionable, perhaps unsustainable, capital structure.

"There is a danger of paying too high a price. The asset value should be independent of the capital structure," Brody continued.

But the European crisis has reached a point at which forward valuations are close to impossible to estimate due to their reliance on the myriad different scenarios that could impact the operations and profitability of potential portfolio companies.

Similar drivers are also affecting secondary sales of entire portfolios. With the impending arrival of Solvency II and Basel III, insurers and banks are already leading a large scale sell-off, bolstering activity in the secondary portfolio market. Additionally, the buyer profile in the secondary market is experiencing a shift: while it used to be composed of few professionals and so-called "tourists" (investors from the primary market), the spectrum is now broadening with more secondaries specialists.

However, the glut of secondary portfolios currently being sold will not last forever, and industry experts point to a reduction in the number of distressed sellers coming to market, leading to rising valuations on portfolios that are coming to market today. Coupled with growing demand, this will make it more difficult to acquire entire mature portfolios that offer attractive returns.

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• Topics
• Performance
• P+P Pöllath + Partners
• EQT
• Montagu Private Equity