The theory used to be that if the smart money is selling, there must be some bumpkin on the other end of the transaction. When financial sponsors looked to exit it would be assumed that they would try to maximize their profits at the expense of the buyers. This was the theory after the eighties, when the more cynical investors would turn a blind eye to the LBO-sponsored IPOs, asking the question: “Why would a buyout shop look to get out of an investment if there’s any more growth to be had?”
However, today times have changed, and an extended hangover in the corporate M&A and IPO markets has forced buyout players to seek out buyers from a previously taboo source-other buyout shops. Advent International, Warburg Pincus, DLJ Merchant Banking Partners, Bain Capital, Welsh, Carson, Anderson & Stowe, JPMorgan Partners, and GTCR Golder Rauner, among many others, have all bought from their private equity colleagues in the past year.
The buyers listed above could hardly be considered rubes of the buyout game. On top of those who have pulled the trigger on these deals, even more firms have participated in the auctions for portfolios companies, and most if not all firms have at least looked at these second hand deals.
This trend begs the question: If the smart money is both selling and buying in the same transaction, who walks away the winner?
“It may sound like a cliche, but I think the best deals you are seeing out there are real win-wins,” says Doug Kingsley, a managing director with Advent. “You can’t do it with every company, but the best opportunities are where you’ve got a rapidly growing business that is well managed in a strong market, and you are able to see what the next five years are going to be like.”
Sparking the secondary buyout trend from the buy side is the fact that LBO firms still have a fully-stocked armory of dry powder at their disposal, with estimates of more than $100 billion of available capital, and buying power of more than double that. The huge fund raising effort in the late 1990s and 2000 created this overhang, and the protracted buying drought following that period has reinforced the need to spend. The LPs, who continued to pay management fees throughout the dry spell, no doubt have pressed the buyout shops about putting money to work.
On the sell side of the equation, the slow exit market, absent the strategic buyers and the public-floatation avenues, has created an environment where buyout firms need to rely on their peers in order to return money to their investors. Survival in the buyout universe demands that money is multiplied and given back to the LPs, and with nowhere else to turn, buyout shops have increasingly shopped their goods to their contemporaries.
However, while both the financial buyers and sellers have used these deals as a way to keep their limiteds happy, not all LPs are convinced the practice actually works-or at least works as the most profitable alternative out there. “There’s got to be a bit of a concern when two groups with similar skill sets buy and sell to each other. It sometimes makes us sit back and scratch our heads,” says Hamilton Lane Chief Investment Officer Erik Hirsch. “From a price perspective, there’s not going to be a bargain to be had there, but what can you do?”
Still, Hirsch allows that each situation is different. “You have to look at each instance to see if you should or should not be concerned…There are certainly times when it works and is not alarming,” he says.
Nick Somers, a partner with New York-based Schroder Ventures, says: “Everyone in our industry is a bit cautious about buying from financial buyers, but there are natural evolutionary planks in the life of a company, and certain sponsors may not be as suited to take it to that next level as others, so sometimes it makes sense to sell.”
Moreover, Advent’s Kingsley notes, “Occasionally, if given the opportunity, firms will look to roll over equity [when selling a majority stake to a financial buyer],” which keeps the buyout shop in the mix for additional upside, while at the same time providing the much- desired liquidity event.
Few are expecting sponsor-to-sponsor sales to dry up anytime soon, although once the strategics re-enter the picture that may be the impetus that pushes the financial buyers back to the sideline in these sales.
However, Somers says, “In the absence of the corporate acquirer, [financial buyers] are the next best thing.” He does concede, though, that the deals are typically being done at lower levels than the sellers would like to see, which to some extent-for those who are keeping score-puts the smart money on the buyers’ side of the transaction.