Private equity firms promise investors they can buy a company, turn it around, and make rich returns on a sale. Since the financial crisis, though, many are finding it harder to cash out, so they’re selling portfolio companies to each other. Through private equity funds, institutional investors can end up as sellers and buyers in the same deal—meaning they have to wait longer for big payouts.
In the first nine months of 2012, private equity firms exited 54 U.S. investments through public share sales and sold 115 companies to other buyout firms, according to data compiled by Bloomberg and London-based research firm Preqin. The sales to other firms generated $33 billion, accounting for one-third of private equity’s total cash-outs, up from 13 percent in the year-earlier period and the biggest share since at least 2006. Initial public offerings and other sales on public markets account for 9 percent of cash generated by U.S. private equity sales, the lowest percentage since 2008. “Secondary buyouts are not necessarily troubling, but limited partners may wonder what deal flow a buyout firm has if it is only able to find investments in another private equity firm’s portfolio,” says Mike Kelly, a managing director at Hamilton Lane, which advises institutional investors.
At least twice this year the California Public Employees’ Retirement System was on both sides of a deal that had been headed for an IPO. Buyout firm Advent International, in which CalPERS had invested, bought TransUnion from another CalPERS investment, Madison Dearborn Partners, in a deal completed in April that valued the company at more than $3 billion. In July, Boston-based Advent completed the $2.7 billion sale of Party City to Thomas H. Lee Partners, in which CalPERS has also invested. CalPERS spokesman Joe DeAnda declined to comment, as did spokesmen for Advent, Madison Dearborn, and Thomas H. Lee.
Most private equity firms give themselves five to six years to start generating returns on their investment, and some will soon need to offer to cash out investors who bought into their funds during the buyout boom of 2005 to 2007 when prices were high and firms completed a record $1.6 trillion worth of leveraged buyouts. “There were a lot of deals held through the downturn that have gotten to the point where funds want to exit,” says Donn Cox, the founder of Sacramento-based LP Capital Advisors and an adviser to CalPERS. “Firms are recognizing getting cost back is better than holding an investment for another five years.” The risk for the second private equity firm is that companies already owned by another firm may have less potential upside, says Robert Durden, managing director of private assets at Chapel Hill (N.C.)-based Morgan Creek Capital Management. Says Durden: “They’re not necessarily turning up diamonds.”