People queue at the box office of Vue cinema at Leicester Square in central London in this file photo. On Monday, OMERS and AIMCo announced they would buy Vue Entertainment, one of the world’s biggest cinema operators.The Associated Press
As the private equity merry go round keeps turning, it's tempting to believe somebody is being taken for a ride.
More and more often, companies are being traded around by private equity owners. Almost a third of the private equity deals last year by value were so-called secondaries, where one private equity firm sells a business or asset to another private equity owner. That's up from 9 per cent in 2006, according to figures from industry tracking firm Preqin.
Monday saw a very big secondary with Canadian connections. The private equity arm of Ontario Municipal Employees Retirement System joined with Alberta Investment Management Corp. to buy cinema chain Vue Entertainment from private equity firm Doughty Hanson, in a deal giving Vue an enterprise value of about $1.5-billion. The purchase came just three years after London-based Doughty Hanson bought Vue.
As such deals increase, the number of primary deals, where a private equity firm purchases a company from public or private owners, has correspondingly declined.
One of the big reasons is that it is very tough to find buyers for many of the companies in private equity hands. The market for initial public offerings globally has been spotty, and corporate buyers have been reticent. Yet some funds have to sell because they have expiry dates and must give money back to investors.
So instead, private equity firms flip companies back and forth. Plenty of trees have been killed and ink spilled as commentators worry that such deals show an industry out of ideas, where returns are doomed because managers are simply handing assets around. If one private equity firm has already eked all the performance out of a buyout target, what is the second firm to own it going to do? Plenty, it turns out.
In a study released earlier this year, Boston Consulting Group tracked 225 private equity holdings over a six and a half year period starting in 2006 and found that those that were purchased in secondary deals performed at least as well as those purchased in primary transactions. What's more, the study found the secondaries had less variability in their returns – meaning they were less risky.
In the case of Vue, OMERS has the advantage of having watched the business for three more years. It bid for it the first time it went up for sale in 2010, but finished second to Doughty Hanson. OMERS has been following the business since and was attracted to the "unspectacular, steady growth" Vue offers from its business showing movies in the U.K. and continental Europe.
"From our perspective as OMERS, does it bother us that this is a secondary, no not at all," said Mark Redman, senior managing director at OMERS. The new owners were able to watch Doughty Hanson expand Vue from a mainly U.K. company to one with operations in countries such as Poland and Germany.
"That European consolidation opportunity certainly existed in 2010, but it was unproven," he said. "Now it's proven."
There are certainly issues with secondaries, such as the fact that fees can "hemorrhage value," he said.
But sometimes one firm has done all it can with an asset, and it is better suited to a second owner with a different skill set, cost of capital or return expectation.
The situation becomes one of "horses for courses – the right investor for the right opportunity," as Mr. Redman puts it.
Certainly the Boston Consulting numbers back him up. The study found the median annual return was 24 per cent for secondary buyouts, edging out the 20 per cent notched by primaries.
Revenue and profit growth in the portfolio companies was neck and neck. Primary buyout targets growing operating earnings at 14 per cent a year compounded, while secondary buyout holdings upped earnings at a 13-per-cent rate. Revenue rose 10 per cent a year for both.
It may get tougher to find secondaries, and not just because they outperform. Preqin's numbers show that, so far in 2013, only 17 per cent of deals by volume are secondaries. IPO markets are still difficult for exits, but some other options are there.
Debt markets that are open and offering cheap money make it attractive for private equity owners to hold on if they can, and instead take out money through dividend recapitalizations.
Onex Corp. on Tuesday announced that one of its big holdings, Carestream Health, would not be sold but instead would borrow money to pay a dividend. Two big private equity firms were looking hard at Carestream as a secondary, Reuters reported.
Also, Mr. Redman said he sees more competition now from corporate buyers.
"Trade buyers are becoming much more aggressive in the market."
( Boyd Erman is a Globe and Mail Capital Markets Reporter & Streetwise Columnist.)
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