Secondaries Roundtable: 'NAV is just a number'

Navigating full pricing, the rise of restructurings and the use of seller financing in today’s booming secondaries market were among the topics debated recently by a panel of market experts.

There’s no denying the secondaries market is thriving. Estimates for last year’s closed deals were around the $50 billion-mark, with pricing at an all-time high and an increasing number of buyers and sellers entering the market.

PEI recently hosted a roundtable in New York with some of the industry’s thought leaders and veterans to discuss the market’s latest trends and challenges.

PEI: All the easy money’s already been made in secondaries, according to a Financial Times column last month. Fighting words or bang-on?

Barry Miller: ‘Easy money’ is a broad-based term. There is probably more competition today … but the reality is there is a lot more opportunity as evidenced by unprecedented volumes of assets brought to market. That means we can be more selective in the transactions we pursue.

Rudy Scarpa: There are still inefficiencies in the secondary market. We need to remember that we’re buying limited partnership interests in private funds that are in turn invested in private companies. While eventually general partners sell those companies at their market value to generate good returns, a portfolio company’s current net asset value (NAV) doesn’t always equate to current fair market value and that translates into market inefficiencies. As long as inefficiencies persist, there are opportunities for secondary buyers to generate attractive returns.

Joseph Marks: Rudy refers to inefficiency; another term might be ‘pockets of value’ and I think that whether it’s a deal’s complexity that it gives you an opportunity or a smaller without as much fanfare transaction, there are always pockets of value in the marketplace. There is a certain degree of randomness in every transaction and not everybody can focus on every deal at the same time.

PEI: But what about today’s full pricing environment? Surely that’s a challenge. 

Adam Howarth: It’s really about selecting the right assets where you see real future value potential. We buy LP interests but really what drives value is the underlying cash flows.

You also have a lot of liquidity in the markets today that you maybe didn’t five years ago, when there was a lot more uncertainty. So [with] a combination of visible exits plus being able to project [underlying assets’] future value, I think you can really [take your] pick in today’s market and find things that appreciate. And as I look across returns in the [secondaries] industry the last five years, there is a pretty strong track record and that’s been in a high-priced environment.

Brian Mooney: Pricing has never been higher in terms of percent of NAV, but that’s too easy a number to focus on. It’s rarely the right way to think about the assets you’re buying or selling. When we’re advising someone on the sell side we try to get them away from focusing on ‘what percent of NAV am I getting’ toward ‘what percent of the future value discounted to today does the offer price represent?’

Miller: It’s a starting point. NAV is just a number and you start from there – you move forward and you figure out mathematically what kind of rate of return you’ll get.

Patrick Knechtli: Headline secondary pricing reflects mostly the bigger transactions – the larger portfolios of well-known, brand name buyout funds that are being sold. They are often priced fully and in some cases have leverage applied to them, which again boosts that headline price. [We tend to focus on smaller transactions or lesser-known managers.]

Howarth: I still think the term ‘full price’ is irrelevant because it goes down to the cash flows. And if I buy something at what seemed a premium to the reference date, I can generate cash flows over a whole period – which may be three or four years – that are well in excess of what that cash purchase price was.

So we are not as concerned about what the price is vis-a-vis the NAV because that’s so fungible – is it reference date, is it closing date? Historically it’s always been around that reference date NAV that people have benchmarked to, but you can kind of use anything you want to.

Mooney: I don’t think all the easy money has been made, but return expectations are just different. Years ago the substantial majority of what was transacting were sellers who needed liquidity or were getting out of private equity. There was a price, the buy side was fairly limited and buyers were targeting returns, for a lower risk asset, well above what primary investors were targeting. That’s changed now, at least in my opinion, where secondaries are less risky than primaries and now are generally underwritten to a lower return expectation than primaries.

PEI: What should return expectations be?

Howarth: I think it’s really tough to define. There are so many different strategies, so many different groups focused on different assets, different types of transactions, different structures, different risk profile underneath there. But clients that we talk to are looking for some sort of premium over the public markets – whether that’s 300 or 500 basis points net, I don’t know.

Miller: That’s the key: they’re looking for premium that is a liquidity premium. The challenge [when talking about returns] is people always talk about ‘private equity’, but it is asset dependent. If you look at private equity it is buyout, mezzanine, venture, growth, U.S., Europe – it is important to define what people are talking about.

PEI: Let’s go back to this notion of ‘pockets of value’; what types of deals are you finding most attractive?

Knechtli: Secondary players tend to focus on where they have good knowledge and insights. So for us, we target smaller-cap funds that don’t typically trade on the secondary market very frequently. When they do come up, we are usually in a favoured position, usually both because of the information we have on the underlying portfolio, but also the relationship we have with the manager as well. We are trying to use our primary and co-investment platform to position ourselves well in secondary deals.

Marks: In our case, we focus on the small-end of the market where there are better pockets of value than the larger or broader auction channel. That provides interesting options that are often off the radar of larger funds. We also leverage our primary platform.