The falling knife

For limited partners hoping to sell private equity interests on the secondary market before year-end, getting an acceptable price is no easy task at the moment.

Public market volatility has led to decreased valuations for secondary stakes, widening the bid-ask spread just as institutional investors rush to close ‘clean up’ trades.

“Historically, it has always been the case that [secondary] deal volume increases in the latter part of the year as people try to clean up their balance sheets by year end,” says Harvey Lambert, head of private equity secondaries at PineBridge Investments. “I think what’s beginning to happen is that deals are taking a little longer to close.”

Some LPs are simply refusing to budge on price. “I’ve seen some sellers say: ‘I don’t care if market pricing has declined by 10 percent, I’m only going to sell in the 90s, and if the market isn’t there then I’m just not going to sell at all,’” says HarbourVest managing director John Toomey.

As one manager put it: when it comes to secondaries pricing, 80 is the new 90.

Buyers, meanwhile, have also appeared reluctant to pay prices that might have looked attractive even just a few months ago. “What we’re hearing from intermediaries is that many of the ‘consistent buyers’ are on the sidelines,” says Toomey. He thinks this will continue until the end-of-third-quarter valuations are released. “I think it’s logical that many buyers will wait to see what happens with 30 September values and also to get better visibility with what’s happening in the overall economic environment.”

After a record first half of 2011 for secondaries – volume hit about $14 billion, according to Cogent Partners – deal flow in the second half has not been as strong. “I think that we may see some slow down from the first half of this year,” admits Lambert.

But there’s still a chance that 2011 could outstrip last year’s record $23 billion or so of secondary transactions, he says. “We’re still seeing some of the big public plans entering the secondary market as they continue to rebalance their portfolio.”

However, they’re far less likely to sell off huge portfolios. “Generally they’re selling either smaller assets or very select assets out of their portfolio, as opposed to either a wholesale exit from the asset class, in the case of financial institutions, or a major sell-down to bring allocations back into line, the way we’ve seen some pension funds do,” Toomey says.  

In Europe, the picture looks similar. “The third quarter certainly was slower, without a shadow of a doubt,” says Erwin Roex, a partner at Coller Capital. “Whether that says something about the fourth quarter remains to be seen.”

One difference between banks and pension funds, Roex says, is that financial institutions are more willing to entertain structuring of the deals. “Even though they might not get the entire price upfront, the package as a whole works for them. Whereas pension funds, being less evolved in financial structuring, are generally not that open [to the idea].”

Either way, the overall message is clear. “Sellers need to adjust to a new economic reality,” says Jason Gull, head of secondary investments at Adams Street Partners. “Ninety-five cents on the dollar is no longer the new market reality.”