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Secondaries: The year of the seller?

Secondary market deal activity declined dramatically in the first half of 2013, amid strong public markets. Secondary buyers have been waiting for the floodgates to burst open.

Talking to secondary market professionals about the dynamic in 2013, the term “window of opportunity” gets thrown around a good bit. Many have been sitting around this year waiting for sellers to open that ‘window’ by coming to the market. 

Deal activity on the secondary market in the first half of 2013 was more than 50 percent down on the equivalent period in 2012, according to the latest pricing report from Cogent Partners. In 2012, the market saw about $13 billion of activity; this year, around $7 billion of deals were done.

However, Cogent believes total secondary deal activity for the year will be somewhere between $18 billion to $20 billion. Placement agency and secondary advisor Triago takes a similar view, pegging likely deal volume for 2013 at around $20 billion. 

For this to happen, activity will have to pick up substantially in the second half. And this would have to be driven not just by the many small and specialised transactions that have dominated the market so far this year, but by large portfolio deals as well. 

As things stand today, it does appear that deals are starting to trickle back into the market. The hope among secondary buyers is that this trickle will become a flood in the latter half of 2013. 

“I just don’t think the supply was enough in the first half,” says Hugh Perloff, managing director with Portfolio Advisors. “And the supply that was there wasn’t really supply, it was people putting out feelers – if people met their expectations, they sold. Now we’re seeing more stuff coming into the market. I’m of the opinion that the second half will be much more active than the first half, which is traditionally the way the market has run. I’d like to believe we’ll see some pretty robust activity.”

WHERE DID IT ALL GO?

So far, 2013 could be characterised as the year of the seller – a period when vendors had access to some extremely attractive pricing for assets. 

According to Cogent’s half-year report, pricing levels remained strong throughout the first half of 2013, with the average high first round bid for all funds at 84 percent of net asset value, up from 80 percent of NAV in the second half of 2012. Pricing was particularly robust in the buyout segment, which saw average high pricing of 89 percent of NAV. 

Despite pricing levels, many sellers chose to stay out of the market. The reason? Several secondary professionals have told Private Equity International that it ultimately boils down to a “fear or greed” calculation. As long as sellers are confident that the public markets will remain strong, and net asset values continue to rise, they will be happy to hold on to their private equity stakes for at least another quarter. After all, what is the motivation to sell?

The Dow Jones Industrial Average broke through a record 15,000 earlier this year – a symbol of the high-flying nature of public equities. Marketable securities are generally the largest piece of an investment portfolio, and so strong performance will raise overall fund performance, potentially under-allocating private equity. 

In this situation, selling private equity would under-allocate an institution even more, so it may not make a lot of sense to pursue secondary sales, which also raises the issue of where to put the proceeds — back into private equity?

“Assets seem pretty sticky in owners’ hands today,” says John Toomey, managing director with HarbourVest Partners, who works on the secondary team. “Many prospective sellers have the attitude of: ‘Why sell today when I can hold on for a higher price and higher NAV in the future?’ [But] that won’t go on forever. Eventually the pendulum will swing from greed to fear – and sellers will start to sense: ‘Maybe I missed the boat and I need to sell as soon as I can’.”

It’s notable that large portfolio sales have been largely absent from the market this year, with the exception of some activity from European banks. “The traditional type of deals are more difficult in this market,” says Perloff. “You have to work hard to source them [and] you have to keep pricing discipline.” 

However, Canada’s Public Sector Pension Investment Board, which oversees about C$76 billion in total assets, brought a portfolio of around eight fund interests valued at about $1 billion to the market in the summer, several sources in the market told PEI in July. At the time, the portfolio was one of the biggest on the market in the year to date – and was perceived as a potential sign of things to come in the rest of 2013. 

RESTRUCTURINGS AND DIRECTS

Nonetheless, despite the slowdown in activity, $7 billion of activity in six months is not to be sniffed at. 
And as Cogent pointed out in its pricing report, although some of the more traditional sellers (i.e. financial institutions and pensions funds) have been less active, new groups of sellers have continued to emerge – including GPs needing to restructure ageing funds. 

“As many funds raised in the late 1990s and early 2000s approach or extend past the end of their finite terms, managers are now increasingly proactive with respect to alternative liquidity methods that both alleviate timing pressure and expedite the return of capital to their investors,” Cogent said. 

Earlier this year, HM Capital Partners was broken apart with help from secondary firms, illustrating one model the market can use to inject life into older funds and firms. 

HM Capital’s food and consumer products team was spun-out in a $606 million transaction by the Canada Pension Plan Investment Board. The pension fund used $468 million to buy a portfolio of food-related companies from HM Capital, managed by the newly-formed firm, Kainos Capital. CPPIB also committed $138 million to the Kainos fund, which was targeting $400 million. Existing HM Capital LPs had the option of rolling over their interests into the new vehicle. 

Separately, HM Capital’s energy investment team also spun-out from the firm with the help of secondary firm Landmark Partners. Landmark financed the creation of a $400 million vehicle to house two energy-related portfolio companies. The vehicle is being managed by Tailwater Capital, a new firm run by former HM energy specialists Jason Downie and Edward Herring. LPs in HM Capital’s prior fund also had the option to run their interests over into the new vehicle. 

The transactions splitting different business lines out of HM Capital, a firm that has been winding down, is one way the secondaries market (or even other interested parties like large pension plans), can help breathe some life back into older funds. 

There are of course other ways to go about restructuring old funds in order to generate liquidity for limited partners (including direct deals simply buying strips of portfolio investments out of funds). But whatever the model used, it’s clear that the market for GP-driven transactions is large and growing. One estimate from Pantheon has just under $100 billion of net asset value residing in about 250 funds that are at least 10 years old. 

“There’s demand from buyers, and we see many GPs looking to clean up old NAV to raise the next fund. We don’t see that dynamic changing in the short run,” says Larry Thuet, senior managing director with Park Hill Group. 
So it looks like there’ll be at least one window of opportunity open to secondaries players for a long time to come…