Returns, the second time around

Meanwhile, other parallel expectations have long persisted that secondary buyouts, and even tertiary and beyond, would increase in Asia as part of the overall maturation of the region. Some recent deals support these expectations: others do not. So are we on the verge of a wave of secondary buyouts that could build to European levels, or is Asia fundamentally different?

Same, same but different

GPs operating in the region have already observed that secondary buyouts are being seen more and more in Asia. “Secondary, and even tertiary buyouts, have been an accepted form of exit and deal source for PE funds in the US and Europe for a while now, so its no surprise the trend is taking hold in Asia,” avers Andrew Liu, CEO of Unitas Capital. Meanwhile, “Investors are looking for new investors and owners for their portfolio companies,” confirms Ken Hao, MD with Silver Lake.

However, this level of activity is different from the wholesale transition some have been predicting. For one thing, secondary buyouts are an older phenomenon in Asia Pacific than the latest headlines about big-ticket transactions might suggest. The biggest secondary buyout to date involving purely independent financial sponsors was completed in December 2007 by Advantage Partners, Coller Capital, and Lehman Brothers Private Equity with their c.$2.2 billion buyout of Japan’s Tokyo Star Bank from Lone Star. Permira’s $2.13 billion buyout of Arysta LifeScience Corp. from Olympus Capital and its co-investors Lehman Brothers and Bank of Tokyo-Mitsubishi UFJ, was completed in October 2007.

Indeed, only two post-2008 deals make it into AVCJ Research’s Top Ten Asian secondary buyouts to date, and one of these – the almost $4 billion acquisition of Singapore’s Temasek-backed Chartered Semiconductor Manufacturing Ltd. by the UAE’s ATIC – was transacted between two government-connected entities. Judging by this data, big-ticket secondary buyouts have been more a product of the high-leverage, pre-GFC boom times than the post-GFC capital overhang.

These deals, when they did occur, were mostly associated with Japan and other more mature markets, and were driven by high expectations – and capital volumes – rather than the levels that turned out to be available. “I was looking at the larger transactions in Japan, and I was quite amazed at how many transactions are indeed secondary buyouts,” remarks Jie Gong, VP at Morgan Stanley Alternative Investment Partners. “It was a reflection of the capital inflow versus the opportunities.”

Also, even if they are becoming more popular, there is no sign yet of Asia Pacific secondary buyouts scaling to anything like Western heights. In Europe, for example, according to some figures, secondary buyouts reached their highest level ever as a proportion of total deals, at 47% of all transactions, over the first half of 2010. Asia Pacific has some way to go.

Secondary buyouts and strategics

Secondary buyouts are also inextricably linked to strategic sales and strategic appetite: a PE firm may or may not have its reasons for seeking an asset owned by another, but it cannot ignore the impact of corporate demand on pricing and availability. Despite the global overhang of PE capital, Asian deals seem to be favoring strategics. MBK Partners’ Cable Network Systems in Taiwan was widely forecast to go to a secondary buyout: instead it went to the chairman of aptly-named Want Want Holdings in Asia’s biggest trade sale of 2010. Affinity Equity Partners scored an unreported but apparently highly profitable result with the sale of its pallet business Loscam to China Merchants Group, despite strong reported interest from CHAMP Private Equity and Pacific Equity Partners.

Asian corporates, which have broadly avoided the crisis, are now cashed-up and little constrained by forgiving governance regimes. They appear ready and able to pay high acquisition multiples. Western multinationals, meanwhile, appear ready to pay a premium for Asian growth, as Amplifon did in buying National Hearing Care from Crescent Capital Partners. The region’s would-be secondary owners, meanwhile, find that the same constraints on leverage price and supply that now constrain them when doing primary deals hold them back when it comes to matching bids from the strategics.

In addition, one of the major value cases for a secondary buyout is less likely to apply in future: the opportunity to take advantage of changes in the capital markets to put together a different leverage structure for an asset.

Risk and returns

Secondary buyouts do at least have one potential advantage, which is risk mitigation. In Asia, due diligence is especially critical because companies may have far more hidden issues than in traditional Western transactions, especially in emerging markets like China or India. Even in jurisdictions like Japan, accounting practices can be far more opaque and unfamiliar for some secondary buyers.

There is a countervailing risk, though. GPs have historically fought shy of giving warranties on sales to other PE firms, leaving the buyers dependent on the warranties and tax covenants given by the investee management. And secondary buyers may see less risk if they skimp due diligence than they would as primary buyers.

Asian secondary buyouts could in theory have more potential to deliver returns than those transacted in more mature markets. “There is a little more room for operational improvements in Asian secondary buyouts,” avers Liu. “A lot of the early Asian buyouts made their returns from deleveraging, growth, multiples expansion, and making some easy fixes to the business operations. In the US and Europe, some of these companies have gone through a couple of PE owners and the business operations are probably quite lean already.”

However, few see enough justification in this to support Asian secondary buyouts across the board. While agreeing that, in some cases, a new secondary owner can bring added value, Hao cautions that these instances are, “very case specific.” Jie Gong cites one possible instance. “If the first owner is a generalist, doing a number of things for the company on corporate governance, capital structure, and management, before turning this over to a specialist with a lot of domain knowledge, there could be another strong leg of value creation.”

A secondary buyer will usually do its best to project its case as a value-accretive buyer. “It’s a little hard to conclude from the outside whether those claims really are true,” points out Jie Gong. “Only time will tell and test whether those claims can withstand reality.” And, as LP investors in this long-term illiquid asset class know, time is often on the GP’s side when it comes to demonstrating value.

Value add and LP attitudes

Liu emphasizes that, though there may be more room to add post-investment value in an Asian secondary buyout, the new owners will have to work for it. “It is safe to assume the low-hanging fruit are gone, so GPs have to work harder to drive through operational improvements in a secondary buyout. Paying the right price and having a strong team of seasoned operators in place is crucial.”

The notable secondary buyout successes of 2010 do suggest that GPs and LPs alike are looking for real value-add to close a transaction, rather than simply the opportunity for capital recycling. CHAMP Private Equity’s June exit of Study Group International is a prime example. The buyer, Providence, counts educational plays as one of its core specializations.

Further, much of the future growth potential for this already very successful asset involves signing up collegiate and other higher education relationships in the US, to appeal to Study Group’s core Asian client base. Providence is clearly better positioned to do this than CHAMP. Such factors account for the c. $523.6 million price tag on the deal.

As Jie Gong observes, although they are “not something that LPs will be very excited about, it would be too cynical to say that all secondary buyouts are unnecessary deals, because there are some with a genuine reason.” However, comfort levels with secondary buyouts among LPs in Asia are likely to remain low. Silver Lake’s Hao notes that LPs remain “concerned, unless there are specific extenuating circumstances.”

In many situations, auctions for secondary opportunities simply are not coming off. Advantage Partners is reportedly seeking new investors for the SPV set up for its own Tokyo Star Bank secondary buyout in 2007. Goodbaby in China, now apparently going IPO after failing to find secondary buyers, is one of several recent examples where new financial sponsors were not forthcoming. As Andrew Whan, Partner at Clifford Chance, observes, pricing discipline and assessment of possible value creation do not seem to be fraying. “If anything, the bar has been lifted even higher than pre-Crisis. Some good evidence of that can be the number of failed or very slow-moving auction processes that we’re seeing in the secondary space.”

Finally, secondary buyouts have the overall effect of ultimately reducing distributions and limiting the flow of money out of the asset class – not an ideal solution for an industry still burdened with too much capital. Portfolio companies sold from one firm to another keep the value of the transactions within PE, whereas many LPs are looking to get money out of the asset class.

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• Topics
• Performance
• Secondaries
• Secondaries
• Advantage Partners
• Coller Capital
• Lone Star Funds
• Permira Advisers
• Olympus Capital Holdings Asia
• Temasek Holdings
• Morgan Stanley
• MBK Partners
• CHAMP Private Equity
• Affinity Equity Partners
• Pacific Equity Partners
• Providence Equity Partners