The first half of 2020 has been one of extremes for the secondary market. Fundraising has blown past previous records, the estimated $50bn raised for secondaries in the first six months is beating any full-year since the market’s inception with investors anticipating a jackpot opportunity. On the other hand, overall transaction value declined more than 56% to just over $20bn in the first half of 2020 as the pandemic gripped the world. However, a more nuanced look is showing smaller secondary deals as being a potential bright spot for the market this year. Here, we explore what is unique about PE secondaries at the moment and in particular the factors driving interest for these smaller deal sizes.
• 6 min. Read •
Large deals plummet while smaller buyers see opportunity
While steep, the 39% fall in deal volume to 543 transactions is not as precipitous as the decline in value. This is a function of an absence of large-scale deals being completed, which has pushed the average trade price down by nearly 28% to $37.2m.
One reason why PE secondary value has been limited in spite of record levels of dry powder in the system is the challenge of structuring large portfolio deals. The particular conditions of this crisis have created obvious winners (i.e. e-commerce, gaming, streaming entertainment, pharmaceuticals, & healthcare) and losers (i.e. manufacturing, traditional retail, tourism, leisure & hospitality). This sectoral performance gap is proving to be tricky. In recent years large secondary funds have stepped in to soak up the growing supply of private equity inventory, initially from banks succumbing to greater regulatory oversight following the GFC but also pension funds, endowments and other LPs seeking to manage their portfolios in bulk. On the sell-side, financial institutions needed a quick, easy solution; on the buy-side, demand for secondaries meant that specialist funds were happy to oblige, notching up the largest deals ever recorded.
Such was the diversified nature of these transactions that leverage became the rule rather than the exception given the level of diversification in $1bn-plus deals meant their downside risk was appropriately adjusted. In deals involving tens of funds and hundreds of underlying portfolio companies, secondary funds were essentially engaging in index strategies. However, now, to cushion against further losses in exposed sectors, bidders are having to price in discounts that may be too large for sellers to accept.
This has in turn created a bias towards selective deals by smaller secondary funds and opportunistic buyers. In taking a more precise approach and acquiring single fund positions, buyers are able to fine tune their offers and minimize downside pricing margins. In theory this more nuanced side of the market is seeing activity across the board in terms of industry sector, manager quality, and states of asset distress as buyers buying smaller stakes are able to take a more meticulous look and provide fair pricing on a case by case basis. In reality, there is expectation that 2020 will not only be the year of smaller deals but a flight to quality in favor of non-cyclicality, assets with limited leverage and GPs that have proven their worth through economic cycles.
This will likely be a temporary phenomenon — for how long exactly is anyone’s guess. However, in the meantime, buyers with dry powder will want to deploy capital and take advantage of situations as they arise in the market.
Sellers: anticipating opportunities and market movements (plus dry powder)
Of course with declining markets, discounts on the NAV of secondaries will be a reality for investors. However, it is for that reason that maximizing pricing is key. As mentioned before, smaller listings are growing in popularity as single fund sales are attracting more specialized buyers, capable of correctly assessing a position’s value. In this regard sellers are now finding an opportunity to participate more actively in PE secondaries. Not long ago the common perception was that only large deals had the scale to successfully transact in the secondary market. However, that has changed quickly over time as more and more secondary funds are not only raised but created and as tech platforms start reduce the perceived complexity of the process (especially for LP-leds) and bridge the gap between sellers and buyers.
LPs are particularly attentive to funds that have already reached target returns. This is where investors are really becoming proactive as they seek to reinvest proceeds into discounted/valuable opportunities flourishing on the market. Other investors also drawn to liquidity are taking the opportunity to reduce the administrative burden that arises as older funds accumulate in portfolios over the years. Moreover, the volatility and uncertainty prevailing in this period of Covid triggers a need for investors to make adjustments to their PE portfolio. These LPs are divesting from non-core PE funds allowing them to shift away from certain strategies/sectors/geographies and move towards more stable, prolific investment opportunities. Lastly, there is the matter of rebalancing for investors. As noted by Unigestion’s post-Covid research paper, the excessive use of leverage by some LPs before the crisis eventually leads them to rebalance their portfolio by listing some of their private equity interest.
Technology fueling success in the face of travel bans
With planes grounded and borders closed, professionals in almost every industry have had little option but to overcome these obstacles through technologies that allow them to continue business from the comfort of their living rooms. The case is no different for PE and PE secondaries in particular. At Palico we are supporting that effort with an online platform that facilitates relationships between PE investors in the face of travel restrictions. Designed by PE secondary professionals, the platform provides a standardized process for investors who wish to sell PE fund interests (whether single fund stakes or portfolios). Additionally, the digital marketplace hosts a vast global array of vetted PE secondary buyers (including almost all major PE secondary funds) leading to dynamic interactions and fostering a multi-bidder environment to maximize price of deals — especially important for those smaller deal sizes.
About Palico
Palico is the leading digital marketplace for private equity primaries and secondaries. Our digital platform is designed for LPs, from single family offices to large pension funds, to streamline investing in PE funds on our Palico primary marketplace and for buying and selling PE fund stakes through our Palico secondary marketplace.
Want to learn more or just see how the platform works? Please contact us to talk, or book time on our calendar, to chat.
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