Let the good times roll

They say money makes the world go round. But sometimes it looks more like the money is moving while the world stands still.

Welcome to the world of the private equity secondary, a merry-go-round of money. Analysts have long said that the secondaries' time would come. As certain an indicator as any was last year's fundraising frenzy, with vehicles such as Goldman Sachs' $1bn fund lining up for business. The boom in private equity may now be a busted flush but among the overpriced dross are some bargains. Nicely de-risked, courtesy of another financial buyer's due diligence and going cheap because someone, somewhere has lost patience with it.

Within days of the start of the new year, the private equity world had learnt of Jeremy Coller, of the eponymous Coller Capital and the sine qua non of private equity secondaries, and his purchase of an 80 per cent equity stake in Lucent Technologies' corporate venturing portfolio. The deal was pretty small beer for struggling Lucent and was never going to completely cure its hangover from the days of the boom, but it was still going to take all the Nurofen it could find, and Coller happened to have some in his pocket, right here, right now.

His team say they have looked at over a 100 similar opportunities in the last 18 months. With this kind of supply in the market, it is no surprise they claim a conversion rate of less than 1 per cent. And there won't be a shortage of opportunities going forward either, what with corporate venturers as eager now to exit at the bottom of the curve as they were to enter at its peak. The trick in secondaries is to avoid the lemons and buy quality at a discount.

And aprés Coller and Lucent, le déluge. As sure as 2002 starts with a two and ends with a two, it is the year of the secondary. Chunks of portfolios, even entire portfolios, will change hands because investors are seeking liquidity before their investments mature. But at what cost? That more often than not will not be disclosed. The pain and shame of disclosing the true value of a billion dollar portfolio, now the market correction has revealed its real worth, will be too great to bear. And it will make limited partners start to ask some pretty challenging questions.

The irony comes when the limited partners are invested in both primary and secondary funds. No one is keen to own up to such a situation, but for many it cannot be far away. Let's say Lockley's Urban Metropolitan Public Retirement Superannuation Fund (Lumpers) bought into the buyout of Widgets, a widget manufacturer, through its investment in MegaBank Partners' semi-captive fund. The fund, unfortunately, invested at the top of the market and is proving an embarrassing drag on the bank's earnings. MegaBank is dying for a way out.

In steps Last Chance Capital, which Lumpers is also invested in. Last Chance bids successfully for MegaBank Partners' portfolio. For the beleaguered limited partner, it is like moving your wallet from your right pocket to your left and being charged for the privilege. Two sets of fees, two sets of promises, two lots of carry, someone had better make some money soon. Or the limited partners will get restless.

Eventually, Last Chance Capital successfully exits Widgets, the company that Lumpers bought twice, through an IPO, managed by MegaBank, and everyone makes a pretty pound. Lumpers, though, has paid a hefty premium for a slice of the asset as it bought it for a third time on the public market. Private equity, the asset class, has saved the day ? and is ready for some more action: Widgets does well for a few years, but soon its sector falls out of favour with the market. Lumpers' quoted equity fund manager dumps the stock. Private equity houses, looking to take the firm private, start to line up: has Widgets thought of doing a public to private?

The world makes the money go round. Welcome to the cash carousel and happy new year

Nicholas Lockley is private equity correspondent of Financial News.