With robust pricing and more than $35 billion of dry powder still to invest, one would think the secondary market would be alive and kicking. However, snapping up secondaries is not as straight-forward as it was in 2011 and 2012.
For one thing, there are fewer large portfolio sales by banks than in previous years. The revival of the public markets has meant that some LPs have seen their private equity allocations fall in relative terms (because other assets have risen in value). With distributions up, LPs have less urgency to sell. And with NAVs on the rise, potential sellers are reluctant to offload holdings that could potentially increase in value quarter-on-quarter.
“The traditional LP secondaries have, in many instances, become somewhat commoditised”, says Andrew Hawkins, founder and chief executive of NewGlobe Capital. “It’s very competitive: people are paying par or close to par for the top assets and the returns are probably not going to be as good as they have been historically.”
As a result, says Hawkins, “an increasing number of secondaries firms have turned their attention to structured transactions”.
This view is echoed by Bruno Bertrand-Delfau, co-head of the EMEA private equity practice at Baker & McKenzie. “To maintain high returns, the sophisticated players may focus on complex or structured transactions and avoid participating in the larger auctions that often go at a very high price,” he says. To enhance returns, many players are exploring more innovative deal structures.
Take the New Jersey Division of Investment, for instance. In June, the pension fund agreed to sell $925 million worth of stakes in real estate funds to a partnership that included NorthStar Realty Finance, NorthStar Real Estate Income Trust and funds managed by Goldman Sachs Asset Management (GSAM).
The sale was structured to include a deferred payment, with an initial sum of $510 million being paid. It was also agreed that New Jersey would receive 15 percent for a three-year period following the closing date of each fund interest. In the fourth year after the closing of each fund interest, distributions would be divided equally between the partnership and the pension fund – and after a four-year period, the buyers would receive all distributions, after paying the final acquisition price. The deal was said to be executed near par – considerably higher than other real estate secondaries deals.
Deferred payments have become more commonplace as a financing tool to improve the headline price, especially for IRR-challenged situations, according to Philip Tsai, global head of UBS’s secondary advisory group. “The concept is nothing new; it’s just [that] the frequency of usage has increased,” he says. “There’s a growing acceptance of these structures.”
“As pricing has strengthened coming out of the downturn, I think the use of deferred is becoming a bit more prevalent,” agrees Joe Marks, a managing director and head of secondaries in investment management at Capital Dynamics.