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Analysis

How selling to yourself became private equity’s go-to deal

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Private equity firms have a new set of buyers for their portfolio companies: themselves.

Blackstone, EQT, BC Partners and Hellman & Friedman are among the buyout groups to have sold companies to funds that they control this year, or made plans to do so.

Although the model emerged before the pandemic, its use has been ignited by it. Lazard estimates that the value of such deals will hit $35bn this year, up from $7bn just four years ago.

With the crisis leaving corporate boards warier of doing deals, the private equity industry has found it harder to keep its simple promise to investors of selling portfolio companies to outside buyers after a set period of ownership.

“The immediate post-Covid recession caused declines in M&A markets and in the ability of [private equity firms] to exit those businesses by selling them or taking them public,” said Holcombe Green, global head of private capital at Lazard. “When traditional routes to exit are reduced, the owners start to look for an alternative.”

The transactions allow firms to hang on to good companies — an attractive prospect as the industry’s $2.5tn pile of unspent money drives up the competition for new acquisitions. They also provide a solution if a buyout fund nears the end of its ten-year life but has not yet sold its portfolio companies.

To execute them, a private equity firm creates a so-called continuation fund, finds investors to back it and then uses it to buy a portfolio company already owned by one of its other funds.

At the heart of the process are groups known as secondary funds, specialist asset managers that raise money from pension and sovereign wealth funds. They are ploughing more of their cash into continuation deals, partly in the hope of generating quicker returns than they would from a traditional 10-year private equity fund.

But as the trend gathers pace, its inherent tensions are drawing scrutiny.

Column chart of $bn showing total value of continuation fund deals

Industry executives say it can be a way of offloading struggling companies that rival buyout firms, trade buyers or public investors do not want. That can leave the interests of those investors backing the continuation vehicles rubbing up against that of the buyout firm selling a portfolio company back to itself.

“It’s either for really high quality businesses people want to keep, or it’s flaky businesses you can’t get rid of any other way,” said a senior dealmaker at a large European buyout group.

Some deals, for example, involve a bundle of companies that can include “a dog and a star”, according to a senior private equity dealmaker, because “if you’re just selling the dog, no one’s going to buy it.” 

One fund manager who invests in the vehicles said that investors simply have to be “pragmatic” about this. If a fund contains five companies of which “two are interesting and three are less interesting . . . you’re solving a problem for [the private equity firm] and you get access to the high-quality assets.”

The momentum behind these transactions — sometimes known as sidecar deals — is expected to build next year.

“I think every single private equity firm will consider doing something like this at some point,” said David Kamo, head of US private equity M&A at Goldman Sachs. “We as a firm are bullish on getting ourselves organised around it” by hiring specialists in the field, he said.

For a buyout firm, selling a portfolio company to itself is now an “option like selling to [another company] is, like an IPO or selling to a Spac,” said Mr Kamo.

Continuation vehicles: How it works

CapVest put French pharmaceuticals group Curium up for sale in what it hoped at the beginning of 2020 could be a €3bn deal. By mid-March that was in tatters as tumbling markets forced buyers, unsure about financing, to step back. CapVest pulled the process and this month completed a sale to a continuation fund that it controls

stage one

Original private equity fund: company or companies carved out

stage two

Advisers call secondary funds, present the private equity firm’s valuation of the company or companies to be placed in the continuation fund, and ask for bids

stage three

Secondary funds say how much they would commit to the new vehicle and at what valuation. They can also include terms on management fees and carried interest. Typically, if a deal needs $1bn of equity, two or three large funds would commit about $200m each

Stage four

Once a couple of large players have signed up, bookbuilding begins: advisers raise the rest of the money from smaller investors on the terms agreed by the bigger groups. In the $1bn example above, they may commit about $25m each

Stage five

Investors in the original fund can buy into the new vehicle or cash out. The private equity firm is expected to keep some of its own money in the new fund too 

stage six

Company or companies transferred to new fund

And with swaths of the government bond market offering negligible returns, money is pouring into such deals. Pension funds have designated $25bn for such deals for 2021, up from $14bn this year and less than $8bn in 2019, Cebile Capital estimates.

Ardian and Lexington, two of the largest secondary funds, have raised $19bn and $14bn respectively for funds whose remit includes such deals. Goldman Sachs Asset Management could allocate about half of its $10bn secondaries fund to continuation vehicles, according to a person familiar with the matter.

As the financial firepower behind the deals swells, buyout groups are in a stronger position to set favourable terms.

Paying carried interest payments to private equity firm’s executives — a lucrative 20 per cent share of profits — in the previously small number of deals used to be a no-go, said Sunaina Sinha, founder of Cebile Capital. But it is now “standard,” she added. “If you look at the deals completed this year, in most of them they would’ve taken something home.”

Secondary funds raise record sums

Private equity firms benefit in other ways, said Eamon Devlin, a lawyer at MJ Hudson, an asset management consultancy. It can, for example, boost their total assets under management, a number many use to market themselves.

With the previously niche practice becoming more mainstream, so scrutiny is likely to grow. Establishing the price at which a portfolio company is sold remains the most contentious part of the process.

“At [its] heart is a conflict of interest,” Ms Sinha points out, as “the buyer and seller are both entities controlled by the same [private equity firm].” There is “nothing wrong” with such conflicts, she added, as long as a fair process takes place to agree a price. 

Some deals, such as Blackstone’s $14.6bn sale of property group BioMed Realty from one of its funds to another in October, involve a “go-shop” process in which bankers solicit higher bids for the portfolio company from outside rivals to see whether the continuation fund’s offer can be beaten.

But according to Ms Sinha and Mr Green, many such sales are not open to outsider bidders.

Investors “want to understand what the actual price discovery process was,” said Mr Devlin. “Some [private equity groups] are forthcoming with what the process was; some are not.”

Selling from the left hand to the right: some of the big deals this year

BioMed Realty: Blackstone sold the group, which leases real estate to life sciences companies, from one of its funds to another, in a $14.6bn deal in October. 

Curium: CapVest sold the French pharmaceuticals business to a new fund that it set up, after an external sale process that had been expected to value the company at about €3bn collapsed in March

IFS: EQT sold the enterprise software business from an older fund to a newer one for €3bn in July

Springer Nature: BC Partners is considering selling its stake in the business to a new fund that it would control, in a deal that may value it at about €6bn

Verisure and others: Hellman & Friedman is selling Verisure and two other companies from a fund it raised in 2011 to a new fund that it will control, three people familiar with the matter said



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Analysis

Iranian TV action thriller delivers warning to Zarif

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It is hardly surprising that Mohammad Javad Zarif, Iran’s foreign minister and nuclear negotiator, is not a fan of Gando, a popular television drama that depicts an incompetent minister who scuppers nuclear talks with world powers by hiring dual nationals who turn out to be spies for MI6.

The series — made by an institute believed to be affiliated to the elite and hardline Revolutionary Guards — “is a lie from the beginning to the end” that “damages foreign policy more than me” by fuelling public mistrust, Zarif said.

By focusing on the nuclear talks, the Guards’ motive goes beyond creating compelling drama, reformist analysts say. Iran is in discussion with western powers about reviving the nuclear deal, a key reformist achievement, and hardliners want to deter the popular foreign minister from declaring his interest in the presidency in what is a crucial election year.

“I’ll be grateful to Gando-makers to let us continue our current job,” Zarif said this month, and commented that he would not run for the presidency.

The possibility of nuclear talks with the US and other powers has complicated an already fraught Iranian political scene ahead of the June election. Many reformists are pinning their hopes on Iran’s top diplomat to reinvigorate the nuclear deal and boost support at the ballot box. Hardliners might prefer to negotiate the deal themselves after the election. The polls are also seen as particularly crucial in case supreme leader Ayatollah Ali Khamenei, 81, dies during the next president’s term.

Pendar Akbari, left, and Ashkan Delavari, right, in a scene from ‘Gando’
Pendar Akbari, left, and Ashkan Delavari, right, in a scene from an episode of ‘Gando’. The series title refers to an Iranian crocodile able to distinguish its friends from its enemies © Bahar Asgari/Shahid Avini Cultural and Artistic Institute via AP

The purpose of Gando, which refers to an Iranian crocodile able to distinguish its friends from its enemies, “is to tell Zarif that should he dare to announce his candidacy, he will be destroyed immediately,” said one reformist analyst. “When the intelligence service of the Guards truly believes in the Gando plot lines, it means even if Zarif decides to defy such warnings, he will not be allowed to run.”

Centrist president Hassan Rouhani is due to step down this year after two terms and it is not yet clear who the presidential candidates will be. Politicians register as late as May and then have to be vetted by the Guardian Council, the hardline constitutional watchdog, which can disqualify nominees. Potential hardline candidates include Mohammad Bagher Ghalibaf, the parliament speaker and a former guards commander; Ebrahim Raisi, the judiciary chief; and Ali Larijani, a former speaker of parliament. On the reformist side, speculation has centred on Es’haq Jahangiri, first vice-president, Hassan Khomeini, a grandson of the founder of the Islamic republic, and Zarif.

A US-educated career diplomat widely respected in the west for his pragmatism, Zarif was instrumental in the historic deal in 2015, under which Iran curbed its nuclear activity in exchange for the lifting of sanctions. But Donald Trump abandoned the accord in 2018, imposed sanctions, including on Zarif, and said he would pursue a new accord to contain Iran’s regional and military policies. The US move emboldened hardliners, confirming to them the untrustworthiness of the US.

Zarif’s background in the US both as a university student and as Iran’s head of mission at the UN — during which he met US politicians including then senator Joe Biden — has long made him a source of suspicion for hardliners.

This wariness of both Zarif and the west is evident to viewers of Gando, as is the heroism of the Revolutionary Guards. Mohammad, the action hero protagonist, warns that western negotiators may sabotage refineries as part of nuclear talks. Mohammad works out of elaborate facilities akin to those in a James Bond film. The fictional foreign minister is advised by a media adviser, the main culprit, “to enter into direct talks with the US and accept the conditions of the leader of the global village”.

Vahid Rahbani in a scene from an episode of ‘Gando’
Vahid Rahbani in a scene from an episode of ‘Gando’. State TV abruptly stopped broadcasting the series that was less than halfway through its 30-episode run © Hassan Hendi/Shahid Avini Cultural and Artistic Institute via AP

The dramatic scenes reflect, in part, the worldview of some of Zarif’s critics. “Reformists, Mr Zarif and his lobby group in Washington [Iranian dual nationals] should be wiped out from Iran’s politics,” said an aide to a senior hardline politician who is a potential presidential candidate. “We have to get rid of this cancerous tumour once for good.”

Gholamali Jafarzadeh, a former conservative member of parliament, said Zarif “is not a good statesman and should not run for president” while “reformists should know that their choices have no chance to be allowed to run”. 

This month, state TV abruptly stopped broadcasting the series that was less than halfway through its 30-episode run. Local media said broadcasts would resume when the presidential race was over. Iran’s centrist president Hassan Rouhani, whose signature achievement is the nuclear deal — alluded to the show on Wednesday and said “people’s money” should not be spent on “fabrication of the truth” and “distortion of facts”.

After three years of sanctions, many voters are disillusioned by the infighting and the prospect of real change, whatever the outcome of the election. “Whether Zarif or a figure more senior than him runs or not, I’m not going to vote,” said Hamid, a 40-year-old engineer. “Let the Guards win the election as they are the ones who are running the country anyway. Why shall I make a fool of myself?” 



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Analysis

Rising inflation complicates Brazil’s Covid-19 crisis

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After seven months in lockdown, Michele Marques received some unwelcome news when she returned to work: while she was away the prices of almost all the products she uses as a hairdresser had soared.

“A box of gloves rose 200 per cent. Colouring products increased at least 100 per cent,” said the 37-year-old from São Paulo, underlining how costs were rising while her revenue had collapsed. “I had to raise the price of my services, too.”

It is a dynamic that is playing out across Brazil, adding an extra layer of complexity to the country’s coronavirus crisis, which has already claimed the lives of almost 350,000 individuals and pushed hospital services to the brink.

With much of Latin America’s largest economy being shuttered, inflation is surging to its highest level in years, fuelling a silent scourge of hunger among poorer citizens that has run in parallel to the Covid-19 pandemic.

“The high price of staple foods — rice and beans, for example — has led to the disappearance of these items from the table of millions of Brazilians,” said Ana Maria Segall, a researcher at the Brazilian Research Network on Food and Nutritional Sovereignty and Security. In the 12 months to the end of March, the price of rice increased 64 per cent and black beans 51 per cent.

“In Brazil currently food inflation has penalised the very poorest, preventing them from having adequate access to food and in many situations leading to hunger,” she said, adding that rising unemployment and the curtailment of social programmes were also contributing factors.

Volunteers hand out food in São Paulo © Alexandre Schneider/Getty Images

Less than half of Brazil’s population of 212m now has access to adequate food all the time, with 19m people, or 9 per cent of its inhabitants, facing hunger, according to a recent report by Segall’s group.

“I’m doing some odd jobs, but it’s not enough to keep us going,” said Jonathan, a 28-year-old who lost his job in the kitchen of a Chinese restaurant in São Paulo when the pandemic began. He said he now struggles to provide enough food for his three young children and pregnant wife.

On a 12-month basis, inflation in June is expected to surpass 8 per cent, far above earlier estimates. In the 12 months to March, food prices jumped 18.5 per cent, while the price of agricultural commodities in local currency surged 55 per cent and the cost of fuel increased almost 92 per cent.

Line chart of Percentage increase over past 12 months showing The price of rice in Brazil is soaring

The developments pose a fresh challenge to President Jair Bolsonaro, who is already under fire for his handling of the Covid-19 pandemic. Across Brazil’s biggest cities, graffiti has sprung up labelling the populist leader “Bolsocaro” — a portmanteau of his name and the Portuguese word for expensive.

The rising prices are also likely to provide useful ammunition to leftist former president Luiz Inácio Lula da Silva, who returned to the political fray last month and may challenge Bolsonaro in elections next year.

“Bolsonaro is to blame for the increase in food prices, he is to blame for everything. They have to remove this guy,” said Maria Izabel de Jesus, a retiree from São Paulo.

Armando Castelar, a researcher at the Brazilian Institute of Economics, said the government had underestimated inflation both in terms of the numbers and also “how much a concern it should be”.

He attributed the rising prices to the devaluation of the Brazilian currency, triggered in part by the stimulus packages passed by the US government — which helped to bolster the dollar and led to higher Treasury yields — and the brighter economic outlook outside Latin America.

“You have a situation where commodity prices are going up because the global economy is going to grow a lot this year. With the growth in the US, interest rates are going up and the dollar is strengthening. This puts a lot of pressure on the exchange rate in Brazil and emerging markets in general,” he said.

As the spectre of inflation loomed last month, the Brazilian central bank raised its key interest rate by 75 basis points, higher than the half-percentage point many economists had expected. A further rate rise is expected next month.

“The central bank acted correctly, but it cannot stop there. It is important not to be too lenient in dealing with this,” said Castelar.

Silvia Matos, a co-ordinator at the Brazilian Economy Institute, also pointed to Brazil’s weakening currency as a contributing factor to inflation. But she said the slide in the real was triggered by investor concerns over Brazil’s deteriorating public finances.

Following the creation of two separate stimulus packages to mitigate the impact of Covid-19, government debt has risen to about 90 per cent of gross domestic product, a high level for an emerging market economy.

The rollout of the second of these packages began this month, with 45m Brazilians set to receive $50 a month for four months.

Critics said, however, these stipends were not nearly enough to keep people both fed and at home in lockdown.

“It is essential that the emergency aid is of a greater value, so that people do not leave the house but no one also stays at home starving,” said Marcelo Freixo, a federal lawmaker with the leftwing PSOL party.

“We need to reduce the circulation of the disease. Brazil is already experiencing 4,000 deaths per day. We will reach 500,000 total deaths by the middle of the year.”

Matos says that inflation had hit poorer citizens much harder than middle-class and rich Brazilians because a larger portion of their income was dedicated to food, the price of which has increased substantially.

“The only thing that could help right now is to get out of this pandemic,” she said.

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Analysis

Can CVC pull off a $20bn ‘deal of the century’ at Toshiba?

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Proposed management buyout looks like an improbable win for the Japanese conglomerate’s embattled CEO



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