Take-privates: Going large

Chinese footwear retailer Belle International appears on track to become a highly profitable investment. Hillhouse Capital and CDH Investments privatized the company in 2017 at a valuation of $6.8 billion, contributing $3.3 billion in equity. This facilitated an exit for the founders while other senior management team members stayed involved. The goal was to bring about a transformation of the business, with an emphasis on new retail capabilities, away from public market scrutiny.

During the three years post-acquisition, revenue and EBITDA are said to have increased 13% and 26%, respectively, through stabilization of the footwear segment and rapid growth in the sportswear segment. The latter business was spun out via a $1 billion Hong Kong IPO last autumn, leaving Hillhouse and CDH with stakes worth $3.9 billion and $807 million at time of listing. They continue to own the footwear division – which, admittedly requires more work – valued at around $3.8 billion.

Belle International may end up being packaged as a private equity value creation story, but Hillhouse and CDH had one big advantage going into the deal: they bought the company at 6.4x forward earnings, which by most accounts was a highly attractive entry point.

This was at the time Asia’s third-largest PE-backed privatization. It happened within a year of the top two, GLP and Qihoo 360. Of the approximately 35 buyouts of $1 billion or more announced since the start of 2017 – excluding energy and infrastructure-related deals – nearly half were take-privates. All of the top six were of this nature. In the three years before that, only 14 buyouts crossed the $1 billion threshold. Again, the take-private share was about half.

This Asia sample is consistent with the findings of Bain & Company’s recently published global private equity report. In 2019, public-to-privates reached their highest level since the pre-global financial crisis boom period. They accounted for eight of the top 10 buyouts of last year.

The rationale is straightforward: give a private equity firm a larger fund and access to abundant amounts of debt financing and they will pursue companies – often in the public domain – that were previously out of reach. Bain noted that buyout deal flow remained on a par with the past five years, despite a worsening macroeconomic outlook. More than three-quarters of deals featured leveraged debt packages of at least 6x EBITDA, up from about 50% four years ago.

Unsurprisingly, enterprise valuation (EV) to EBITDA multiples remain resolutely high – 11.5x in the US and 10.9x in Europe. Over 55% of US buyouts were completed at EV multiples in excess of 11x. In 2015, it was below 40%. Inflation is happening irrespective of sector.

Indeed, Bain identified several ways in which private equity firms are taking a more sophisticated approach to screening public companies, largely so they can get comfortable with high valuations for take-private deals. First, there is a preference for stable companies that might be undervalued, can afford to take on debt, and offer scope for operational gains. Second, mediocre public businesses are being targeted with a view to implementing substantial cost restructuring. Third, distressed situations, where there might be high turnaround potential, are gaining popularity. Fourth, conglomerates are increasingly willing to divest non-core assets, some of which are publicly traded.

As with most large-cap buyout transactions, the key is having conviction, which is usually based on having some kind of edge in terms of operational capabilities or sector knowledge. That’s fine as long as it works. The danger is valuations are becoming so elevated that nothing but Herculean value creation efforts make a difference – and even those might be rendered irrelevant by a contraction in multiples. There is no substitute for picking the right asset and getting in at the right price. 

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• Topics
• Buyouts
• Greater China
• GPs
• Asia