Abundant dry powder fires secondaries prices sky high

Looking at the industry globally, secondaries continued to ride a strong wave last year, with deal volume matching the historic peak of 2014 at $45bn, according to a report issued by industry adviser Cebile Capital. Its managing partner, Sunaina Sinha, sees high prices as one of the reasons for the sustained deal volume, being attractive and encouraging for sellers: "The average price paid for all types of private equity assets in the secondaries market is 89% of net asset value. The discount is 10.7%."

Despite the strong pricing, Patrick Knechtli, partner at SL Capital Partners, says average prices in the past year have come down slightly: "This is due to market volatility, which has made buyers more cautious, but the more important reason is a larger number of tail-end transactions, which tend to consist of assets of mixed quality and so trade at a bigger discount."

Joe Marks, Capital Dynamics' managing director and head of secondaries, agrees that pricing has softened slightly. An additional reason he identifies is the several quarters of slowing S&P 500 earnings growth: "Buyers should take into account a potential slowing economic environment. It does not mean it will fall off a cliff, just that we have enjoyed a very big run since the bottom of the market, so the chances are it can't continue at that pace."

It is important for sellers to understand that even though the average went down a bit, for good-quality portfolios you can get very strong pricing on the market" – André Aubert, LGT Capital Partners

Premium pricing
However, while prices for certain assets decreased, this has not been the case at the larger end of the market, where the biggest funds account for much of the overall deal volume. According to the Cebile report, a handful of buyers have the ability to deploy more than $1bn per year, while 76% of secondaries market players achieved fewer than 10 deals in 2015, without reaching $1bn.

André Aubert, co-head of LGT Capital Partners' secondaries practice, says: "For high-quality portfolios, we still see very strong pricing, which can even be at premiums. It is important for sellers to understand that even though the average went down a bit, for good-quality portfolios you can get very strong pricing on the market."

High demand for successful portfolios, combined with a high level of dry powder, suggests appetite is unlikely to be assuaged in the near future. This is reinforced by GPs such as Ardian and Coller Capital continuing to raise multi-billion dollar secondaries funds.

Loving leverage
A more recent trend influencing pricing is leverage. Despite 81% of respondents saying they do not use explicit leverage, the debt market for private equity secondaries is on the rise. However, in stark contrast to Cebile's survey, a report by UBS found that 31% of buyers use deal acquisition leverage. It also suggests the number of leverage providers in the market has more than doubled since 2012, growing from about five players to around 12 today.

While it remains unclear how many secondaries transactions are using leverage, what is apparent is that the use of debt is commonplace at the upper end of the market. "You need a certain level of diversification, a large number of funds and companies," Aubert says. "Also, debt providers tend to know the big buyout funds. When you work on a small transaction with an obscure name, they typically cannot be involved."

For Marks, leverage is a way to meet price expectations in a market very much in favour of sellers: "Some buyers are feeling more pressure to meet those expectations." He also acknowledges it as a way to increase returns, albeit with a higher risk profile.

As has been the case for private equity in general, the use of debt has become more commonplace in the years following the financial crisis, where debt was harder to obtain. And with rising availability comes more flexibility, with a few banks starting to provide leverage for smaller and more concentrated deals.

Adviser-fest
A growing secondaries market brings with it an ever-increasing number of advisers. The majority of them work on the sell-side, finding buyers and organising auction processes. Part of their job is to increase the purchase price. "They create a lot of excitement and a sense of urgency," says Marks, adding that they can make investors overpay at times. He says their number has increased over the years, estimating they are now used by around 60-70% of the market. However, Aubert values their service: "This is helpful for the market, because they increase transparency, which helps buyers and sellers find common ground for a transaction."

A new trend on the adviser front is buy-side representation, where intermediaries are searching for sellers willing to offload fund interests. This is a newer phenomenon and remains rather an exception than a rule for now. "It is still in its early days. They only sometimes manage to get you into some sort of a negotiated or exclusive situation. Most engagements are exclusive sell-side arrangements," says Marks.

While the markets have recovered after turbulence earlier this year, secondary pricing developments for the months to come are hard to predict. "It depends on public market volatility both in the US and Europe," Sinha says. The markets have calmed down since January, but if they are as volatile as they were back then, we will see prices decline because buyers will want to factor in a buffer to account for volatility in the market." Marks, on the other hand, questions investors' relaxed approach: "The prices I have seen traded, at least for the high-quality stuff, did not show buffers. Now that we had the big scare in January and everything is better, buyers are trying to decide what should be the new normal. They will either change their habits and factor in a buffer, or things will continue the way they are."

• Tweet  
• Facebook  
• LinkedIn  
• Google plus  
• Send to  

• Topics
• Secondaries
• Performance
• Secondaries
• Top story
• Capital Dynamics
• Aberdeen Standard Investments