The rising stock market has increased corporate valuation of companies. This surge has given the secondary private equity market a new life. According to Bloomberg Private Equity M&A database, secondary private equity transactions year-to-date stood at $25.6 billion with a total of 97 deals. Prior to this, the highest activity for secondary private equity market was in 2007 with $114.7 billion in deal value for 316 deals; whereas the lowest activity was in 2009 with $4.1 billion for 82 deals. The private equity market has been criticized as illiquid but now it can sell quickly with only modest discounts to net asset value (NAV).
Private equity investments involve investors such as pension funds, endowments, and other wealthy families and investors. In the private equity business model, these investors act as limited partners pooling money into funds created by large private equity funds, who in turn act as general partners managing the investments. In the secondary market, these investors can buy into companies thereby skipping fees paid to fund managers. However, some argue that private equity funds have certain significant advantages over secondary private equity funds. First, these funds are often initial investors and have the potential for higher return given the higher risk. Second, the secondary market may not have the best opportunities for reasons including the underperformance of assets, and they may sell at a discount to net asset value. A well functioning private equity market leads to a healthy secondary market. According to Triago, a private equity fund advisory firm, the average discount to net asset value has decreased from 35% in 2009 to 7% in 2013.
Furthermore, according to Morgan Stanley Alternative Investment Partners, during the period between 1993 and 2008, secondary private equity funds outperformed private equity funds by approximately 8%. The difference is staggering because secondary funds are safer compared to private equity funds including those in risky venture capital. Secondary funds lose money approximately six times less often than private equity funds. The secondary market helps private equity funds to exit from their investments with ease. From a limited partner’s perspective, however, secondary deals may not necessarily be good. As with many sales they can just go back and forth between private equity firms. But it primarily depends on performance of the asset, such as in the case of underperformance, a new general partner may actually be beneficial by bringing in a new perspective which could be helpful in growing the company.
The largest secondary deal so far this year is the leveraged buyout of Gates Corporation by the Blackstone Group. The transaction has been announced but not confirmed yet; once confirmed, it is expected to close by the end of the year and is valued at around $5.4 billion. The Blackstone Group will acquire Gates Corporation from Onex Corporation and Canada Pension Plan Investment Board (CPPIB). Gates is a global manufacturer of advanced power transmission systems and fluid transfer solutions, and for the most recent year it has generated $2.9 billion in sales and over $500 million in adjusted EBITDA. Onex and CPPIB bought Tomkins, the parent company of Gates for $5 billion in 2010. According to Onex, the sale of Gates and other divisions of Tomkins amount to roughly $7.9 billion in aggregate proceeds.
The second largest secondary transaction again involves Canadian Onex Corporation selling the Warranty Group to TPG Capital for $1.5 billion, amounting to an 18% rate of return for investors. Onex acquired Warranty for a little less than $500 million in 2006. The Warranty is a service contract provider for warranty management, compliance, insurance and underwriting in consumer goods.
According to Bloomberg, YTD secondary raisings were $13.2 billion with the total private equity fund raisings of $147.5 billion. Secondary raisings account for roughly 9% of the private equity fund raisings. The evolution of the secondary private equity market is a sign of a maturing private equity industry. The trend is expected to continue and secondary private equity deals will make up a higher proportion of total private equity transactions.