The global private equity (PE) secondaries market is booming, indicating that sophistication and flexibility are necessary to participate in PE strategies. But while the global trends are clear, the same observation cannot be made about the Australian marketplace.
There are two variations of ‘secondary’ transactions in the context of PE. The first involves the sale and purchase of an institutional investor’s existing interests in buyout, growth, venture and other alternative asset funds. The second variation – sometimes referred to as a secondary buyout – involves the sale of a PE-backed business from one PE fund investor onto another PE fund.
While over the last decade there have been a range of secondary transactions in Australia, the market can be characterised as essentially comprising sporadic, one-off deals. So why is this the case?
The secondaries market was once considered an option of last resort for institutional investors and PE funds. These types of transactions were seen as motivated by attempts to offload underperforming investments, or in response to other pressures, such as new regulations or market conditions.
But in recent years, the situation has changed dramatically.
Global secondary market transactions for institutional investors hit a record US$58 billion in 2017, well above the previous record of US$42 billion in 2014, Preqin global data shows.
Australia’s natural brake
The motivating force behind that growth has been a push towards better portfolio management, changes in investment strategy or, in some cases, a desire to increase liquidity in what is otherwise an illiquid long-term investment strategy. All of those factors are equally valid in the local market, but there are also strong forces curtailing the growth of secondaries here in Australia.
Australia’s economy is robust, but it is far smaller than the home markets of many of the world’s largest PE firms and institutional investors.
This acts as a natural brake on secondary deals – there are simply fewer opportunities for them to be completed.
For institutional investors in particular, key markets such as the US have had active and sophisticated PE investment strategies for decades. That fact alone helps drive a different perspective and strategy for how to maintain the right balance within a portfolio of investments in the asset class and optimise performance for members.
There are also fewer reasons to drive secondary deals because the Australian market is characterised by patient investors, which understand that long lock-up periods come with the territory, and liquidity events driven by more traditional exits have underpinned some of the strongest returns in the world.
Selling down interests in PE-backed investments through sale to strategic buyers and initial public offerings (IPO) remain the primary channels for PE exits in Australia.
Like any developed market around the world, the Australian IPO market experiences up and down cycles over a given period. But overall demand for high-quality IPOs remains healthy, and good opportunities that come to market at the right valuation in the right economic climate will generally find support.
A relevant factor in this equation is the steady stream of compulsory superannuation inflows looking for a home in quality assets. Large Australian corporations are also hungry for acquisitions to propel growth, in a mature market where it can be hard to drive organic growth in a sluggish economic environment.
These factors provide important context for distilling the reasons behind a modest secondaries market in Australia.
In years to come, however, we may well witness an increase in the volume of secondaries market transactions here.
We will probably see stronger relationships forged by PE firms that will explore the opportunity to exit an investee company to another PE firm. This will often occur when one PE firm reaches the point where it feels a different firm can continue to add value to the growth plans of the business for the next phase of expansion.
It is common to see this where larger amounts of capital investment are required to continue to support and build on the earlier work done by the first PE firm, or where the skills required to unlock growth opportunities in the next phase differ from those required in the first phase.
A common example of this is when there’s a difference between skills required to support the growth of a strong-performing business in a domestic market and skills required to grow into offshore markets.
In the Australian market, there are a cluster of mid-market PE firms around the $200 million to $700 million fund size, and there is a smaller but prominent group of PE firms focused on larger deals.
One of the most recognised secondary buyout transactions in recent years involved the sale and purchase of cancer and cardiovascular disease specialist GenesisCare.
The business was originally acquired by mid-market PE investor Advent Partners in 2009, which worked hand-in-hand with management of the business to double its earnings over the coming three years, before selling it to larger international buyout fund KKR & Co.
Over the next few years, KKR continued to add significant value and build the business, before selling to a consortium comprised of state-owned enterprise China Resources Group and Macquarie Capital in 2016.
In the last few months, Australian firm CHAMP Private Equity completed a circa $1 billion deal to sell Accolade Wines to a global PE buyout firm, which is expected to accelerate the company’s expansion into Asia. It was another impressive result for investors, which benefited from the focussed strategic work that CHAMP did to create Accolade from Constellation Wines’ Australian and European business units.
There’s no doubt that there is room for more secondary deals in the Australian market as our market continues to grow, and the opportunities for private capital to drive business growth become more apparent to a wider cross-section of enterprises across the economy.
For institutional investors, the outlook is similarly positive, the consistently strong return profile of PE investment strategies is beginning to attract the attention of institutional investors that may not historically have had PE programs in place within their fund.
Buying a portfolio of investments from an existing institutional investor could be seen by those developing a new program as an attractive way to complement a broader strategy.
Yasser El-Ansary is chief executive of the Australian Private Equity and Venture Capital Association.
