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The PE Shell Game

Is the Private Equity Market Coming Back?

Private equity is showing some signs of life.

Second-quarter deal value surged 60 percent from the prior quarter, making it the most active quarter since 2008, according to Preqin, the London-based experts on any data related to alternative investments.

More specifically, there were 411 private equity-backed buyout deals announced in the second 2010, worth a total of $43.3 billion, compared to the 356 deals announced in the first quarter, worth $27.1 billion.

What’s more, in North America, total deal value more than doubled to $26.7 billion compared to $12.8 billion in the first quarter — even though the actual number of deals fell to 175 from 188. In other words, U.S. buyers were more interested in doing super-size deals.

Preqin also pointed out that nearly half of all deals in the second quarter were leveraged buyouts, accounting for 54 percent of deal value.

The most interesting statistic concerns secondary buyout deals. In the first half of the year, there were 70 secondary buyouts valued at $18.5 billion globally. This was more than three times the value of secondary buyouts in 2009, when there were 59 deals valued at just $6 billion.

What are secondary deals? These are deals when one buyout firm sells a holding to another buyout firm.

This practice is nothing new. It has been around for decades.

But, I always found it to be a curious transaction. Basically, two groups — buyers and sellers — in the same industry with similar needs seemingly help each other out.

Afterall, buyout firms don’t make big bucks until they exit a holding.

Meanwhile, they have near records sums of dry powder — currently $470 billion, down from an all-time high of $497 billion at the end of last year, according to Preqin.

“Private equity firms have money and are looking to spend more of it,” says says Adley Bowden, managing editor at PitchBook, another PE research firm.

If buyout firms want to raise more money, they first need to spend what they have, and at the same time cash out from earlier deals and wind down their old funds (hopefully showing strong returns on investment).

Right now, most exit routes seem blocked or clogged up.

According to Pitchbook, secondary deals as a percentage of total exit strategies — the others being acquisitions by corporations or IPOs — has surged to 28 percent from 17 percent in the fourth quarter. It was also down to 17 percent in the first quarter of 2009 and 21 percent in the third quarter of that year.

However, during the Go Go Years of buyouts several years ago, secondary deals sometimes accounted for 44 percent of all PE exits.

To me, this is a little like musical chairs meets the greater fool theory with a tinge of incest. Buyers with huge sums of capital satisfy the needs of those in the same club who need to unwind earlier investments, and vice versa.

So, they pass around the PE holding to another PE firm with the goal of not holding the asset when the valuation music stops. “It’s a little bit of pass the parcel,” concedes Manuel Carvalho, Managing Analyst for Buyout Deals at Preqin. “They need to invest their capital. And they have investment holdings they need to realize.”

Afterall, private equity firms are very shrewd careful purchasers who use leverage to buy other companies. I highly doubt they are over-paying to beat out interested corporate buyers for these assets.

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