Just over a year ago, something happened in the private market space that we at PitchBook have rarely seen before.
Industrial cleaning specialist HydroChem, a subsidiary of Aquilex and portfolio business of Centerbridge Partners, was merged with Littlejohn & Co-backed company PSC Industrial Services.
While the deal itself wasn’t that exceptional, one facet made it very noteworthy: The transaction marked the sixth time in a row that HydroChem had gone into PE ownership, according to our data.
While a senary buyout like this is somewhat of an anomaly, it is indicative of the growing number of companies being passed from one PE firm to another.
The rise of more traditional private-to-private deals—the secondary buyouts—underscores this. Since the financial crisis, the number of SBOs has risen each year from 2010 to 2017, per PitchBook, climbing from just 564 deals to 1,178 annually in that timespan.
We explored the reasons behind the SBO bonanza earlier this year, with factors such as agitating LPs, record levels of dry powder, rising deal multiples and a lack of public companies to take private helping push GPs in the direction of taking over a rival’s portfolio company. Indeed, for some desperate GPs and LPs, an SBO is the quickest and most efficient way to provide and find liquidity, instead of trying to woo corporate buyers or wading through the bureaucracy of an IPO.
However, it isn’t stopping there.
More of the same
While SBOs are rising, so are buyouts, even beyond that order of magnitude. Tertiary buyouts also hit a high in 2017, per PitchBook data, clocking in at 761. Companies experiencing their fourth PE takeover in a row numbered 55 last year; none of this deal type was even registered 16 years ago. And so far this year, there have been 11 quinary buyouts compared with 14 the year previous. The preceding years haven’t even gotten close to those figures.
Academics and investors have long debated the merits and flaws of SBOs, with no real consensus on their overall worth compared with other PE deal types. Are they an indication of overeager capital deployment or opportunistic? Can another PE investor actually add value where a previous one had missed it? And what do LPs think in cases where they could be essentially on both sides of a deal?
These questions can only really be answered on a case-by-case basis. SBOs conducted near the end of a fund’s investment period do tend to perform poorly, but not all do; PE firms taking a portfolio company from a peer can add value as long as their skill sets are complementary and not alike, but not always; and LPs might not necessarily be too fussed at being on both sides of a buyout given the result is a zero-sum game, but some will be.
Working with what’s left
However, it isn’t just a two-stage process anymore. Tertiary buyouts were more popular in 2017 than SBOs were just six years prior. And while quaternary, quinary and senary deals still make up a small portion of the overall buyout space, the effect on returns of the rising tendency of PE firms to simply pass on their investments to their peers merits discussion. This all comes, as well, amid a backdrop of increasing fund lifetimes, giving investors more bandwidth to keep companies private for longer.
And while praise of SBOs and beyond may be justified, the larger their number the more questions will persist. What, exactly, will a sixth PE firm add in terms of value that the previous five did not? Why can’t IPO windows or strategic acquirers be found for these portfolio relics?
HydroChem’s latest deal may well add that value, and being added on to another cleaning company will have given it new customers and geographical footprints. However, the growing trend of “pass the parcel” among PE portfolios is something to take notice of, particularly as it magnifies the inherent downside of traditional SBOs. Because eventually, one day, the music will stop. And someone’s going to be left holding the bag.
Learn about our editorial standards.
