This article is sponsored by Credit Suisse.
What does it take for a GP-led deal to get over the line in the current market?
The main thing buyers are seeking to understand is how net asset value has been impacted and how it has moved over time. Aside from macro uncertainty, the biggest factor that slowed activity last year was the 20 percent move in public markets in Q2 and Q3, at a time when private equity NAVs were down around 2 percent according to the indices we track.
While everyone expects an element of outperformance, buyers were saying “that doesn’t add up”, and were drilling into those valuations a lot more. In the GP-led space, where deals generally transact at NAV, only a few transactions were seen as attractive, so deal volumes declined.
For a deal to get done today, you need to be able to demonstrate the NAV has moved in line with public comparables and there hasn’t been any kind of reassessment of methodology that has supported it. If the NAV hasn’t gone down, you need to be able to prove that is because of outperformance.
There are still plenty of deals today that firms on the sellside are willing to do at high prices, which means there are a lot of conversations, but activity remains slow when it comes to actually printing tickets.
At the same time, the market is still adjusting to the prevalence of single-asset deals. For sponsors, it’s important to be thoughtful about the size of those deals and how to build a book. For example, identifying which LPs are likely to roll, and getting clarity about that early on, means there may be a smaller book to place among secondaries buyers. Also, building in time for lead investors to offer the deal to their own co-investors before launching syndication can increase their cheque size.
The other route sponsors have taken is to create a multi-asset package. We are finding GPs are becoming more open to that type of transaction versus conducting these processes one asset at a time, as deal certainty has increased in importance relative to the simplicity of a single-asset offering.
What factors are driving pricing in GP-led deals?
Around a quarter of deals transacted at some sort of premium up until the first quarter of 2022, but par is now the new premium. Discount deals are still rare and that is why volumes are currently low. There needs to be a strong rationale for a GP to recommend a deal at a discount to its LPs, so these deals tend to happen at NAV where everyone on the buy side and the sell side can agree that is a fair level.
Buyers very much look at this in the context of the LP side of the market, where we see pricing currently at around 85 percent of NAV today for a typical high-quality fund, hence buyers are currently seeing strong relative value in LP-led deals. We would anticipate that market creeping up closer to par as it gains more confidence in NAVs and starts wanting to deploy more capital. This, in turn, will push appetite back towards GP-led deals seen as offering more alpha.
What innovations have you seen in the last 12 months?
We have worked on a number of deals in the last year that are not actually continuation fund secondaries, in the sense that a manager is selling from fund A to fund B, but rather where fund A retains its stake and the continuation fund is used solely to fund the buyout of minority investors or to fund the acquisition of strategic add-ons, beyond the capacity of the current fund. This model has resonated among buyers because they are not having to find a price at which LPs want to sell.
Instead, you are looking at a price where LPs don’t want to sell but a third party is willing to do the deal at a discount – this cuts across the bid/ask spread challenge presented by a typical GP-led deal. I would expect to see more of these transactions going forward.
What is the outlook for 2023 and beyond?
2022 was a year of two halves, with H1 running at a similar rate to 2021 and then very little happening in H2. We think 2023 will be the inverse of that. It will continue to be quiet for the first quarter and maybe the second as firms figure out whether the recent rally in the public markets is sustainable and what their marks look like in comparison to the ‘new normal’. Funds that have been relaxed about slow deployment since Q2 2022 due to strong deployment in the prior 18 months, will both start to have more confidence in the economy and feel more pressure to do deals going into the second half following a year of slower investment.
On the public markets side, there’s now a light at the end of tunnel when it comes to inflation, but it may well take all year for the interest rate cycle to play out. Still, the impact of that will become more clear as the year progresses. Once there is more clarity on both the sell side and the buy side, we will find prices at which parties will be willing to transact. There is already a high stock of potential continuation fund opportunities and, as soon as the demand is there, those will convert into dealflow.
The other trend we expect to see more of in 2023 is tender offers. There has been a once-in-a-generation event in the primary markets where almost all the big funds were fundraising at the same time, so LPs have had to make tough decisions about who to re-up with. Tender offers where buyers put a staple into new funds make a lot of sense for managers right now, with LPs either not coming back or needing liquidity making interested sellers, and buyers out there willing to put the effort into those processes given the ability to discover a clearing price. The key to these is managing expectations, as buyers are often led to expect much higher sellside volumes than ultimately transpire in these processes.
Will the balance between LP and GP-led deals change?
GP-leds accounted for the majority of transactions in 2020-21, but that flipped the other way in 2022. At the moment, most deals that are transacting are LP-led, and that is because there is a sub-set of LPs that are willing to sell at a discount or allow some cherry-picking of their portfolio to trade at a higher price.
I expect LP deals will represent the majority of transactions in 2023, but GP-leds will resurge later in the year to create more of a balance. If you are an LP that wants liquidity, you can’t sit around waiting for a GP-led, so there will always be the desire for LPs to actively manage their portfolios, whereas GP-leds are now established as an attractive alternative to traditional portfolio company exit routes. There is a structural balance maintained between the two, based on how buyers are wanting to deploy – in most cases 50/50, but with some funds aiming to heavily weight towards one over the other, which means the market will be fairly even over the long term.
Jonathan Abecassis is EMEA and APAC head of capital solutions in the Credit Suisse Private Fund Group