By Tom Bradley

There was news today that two private equity firms, Berkshire Partners LLC and OMERS Private Equity, are buying Husky International from Onex, another private equity company. This secondary buyout (defined as one private equity firm buying a company from another) is part of a growing trend. Late last year, I saw some numbers from Standard & Poor’s that showed that 68% of European private equity deals in 2010 (year-to-date) were secondary buyouts, while 49% of U.S. deals fit this category.

It’s understandable why this is happening. In aggregate, private equity firms are awash with capital and need to deploy it on behalf of their clients. And yet, some of the older funds they manage are in liquidation mode and need buyers for their assets. The public markets have been robust, but a little flaky when it comes to initial public offerings (IPOs). In some cases, a secondary buyout is cleaner, quicker and/or the only option.

I note this trend because I find it hard to see how it contributes positively to client returns in the long term. One of the advantages private equity firms have over other investors is people. They’re reputed to have the best and the brightest. I tend to think this edge has been diluted by the exponential growth of the industry (Private Equity II - Jeremy Grantham's Buyer's Guide), but that’s not relevant here. In secondary buyouts, the ‘best and brightest’ are on both sides of the table.

Given the high fees and time constraints on private equity funds, the managers need everything going for them. It’s hard to see how they’re going to consistently add value for their clients by buying already-optimized assets from equally smart and plugged-in people.

I wrote about private equity funds when they started paying premiums to buy public companies, sometimes even getting into bidding wars (An Evolving Asset Class - "Not-so-private" Equity). To me, that was a big step towards mediocrity. This trend is another. There may be a deal or two where a secondary buyout makes sense, but you tell me, does buying from Gerry Schwartz, who has already squeezed all the inefficiencies out of the company, sound like a good way to make money? Not on your life.

There are lots of terrific people and firms in the private equity space (I have been an admirer and shareholder of Onex for many years), but to me, the raft of secondary buyouts is another sign that this asset class has become too big too fast.