Quaternary buyouts: the private equity market continues to mature

A buyout is the acquisition of a business by a management team backed by private equity finance. A secondary buyout is a buyout of a buyout, a tertiary buyout is a buyout of a secondary buyout and so on. The quaternary buyers are the fourth set of investors to acquire a stake in Gala since the original 1997 buyout from Bass.

Private equity investment is cyclical in nature so fund managers are focused on completing successful exits within the three to five-year time line for the investment in question. In addition to further buyouts, the traditional exit routes are flotation, sale to a trade buyer and insolvency or winding-up (for background information, see feature article "Secondary buyouts: moving on", www.practicallaw.com/5-102-6049).

As the maturing private equity market has established itself, the number of players has grown. This expansion has led to a more liquid market and, with funds to invest, fund managers are increasingly opting for the certainty offered by the buyout exit route. Indeed, there is no reason, in principle, why there could not or should not be a buyout of a quaternary buyout (a quinternary buyout).

Raymond McKeeve, the partner at Linklaters who advised Permira on the deal, and Charlie Geffen, head of private equity and buyouts at Ashurst, who advised the sellers, agree. According to McKeeve: "Quaternary buyouts are a feature of the maturity of the buyout market and will become increasingly common."

A cynic might wonder why an investment would be attractive to a series of private equity investors when others have decided that it is time to cash out, but the market is more complex than that. "Private equity investors," says Geffen, "like those investing in the public markets, will take different views on the prospects of a particular investment, have different approaches to weighting their portfolio and have different funding cycles."

Gala's chairman, John Kelly, has been quoted as saying that: "[t]he value we could achieve via the private route exceeded the valuation expectation we had from an IPO, and there's also the degree of certainty - the IPO process is a long process."

The Guardian reported that the bankers working on a possible flotation valued Gala at between £1.75 billion and £1.8 billion (18 August 2005). This did not compare favourably with the £1.89 billion value the Permira deal places on Gala; which goes to show that these days private equity can compete with the public markets for an investment and win.

As for certainty, Gala's online bingo business may have made it look as if Gala was in an excellent position to take advantage of the public market's love affair with online gaming earlier this year. But with the recent change in the fortunes of PartyGaming on going public and, potentially, 888.com, Gala's decision to avoid the public markets looks increasingly canny.

For the buyer, a quaternary buyout also has its attractions. "The real beauty of a quaternary buyout," comments McKeeve, "is the quality of the management information and due diligence available. There should really be no issues that haven't been thoroughly explored." Warranties tend not to be considered to be key in terms of risk allocation at the quaternary level and are used mainly to elicit information from management and affirm their commitment. The added expense of insurance cover is not usually thought necessary.

In fund-raising terms, much of the basic work of establishing credit relationships has been done and the target's debt may already be syndicated in the market. "Similarly," comments McKeeve, "the management team at the target will already be in a private equity mindset so you don't have to go up that learning curve again." As one might expect, senior management at Gala will be staying in their roles (for a feature article on the issues facing management, see "Management and MBOs: risks and rewards", www.practicallaw.com/3-201-0755).

Buyouts are likely to continue to be such a commonplace exit route that the fact that an investment is owned by a series of funds will come to be seen as nothing remarkable at all.