every second€¦ · every second counts at the table (clockwise, from left) nigel van zyl sj...
TRANSCRIPT
www.realdeals.eu.com REALDEALS 13
Against all expectations, 2009 was another quiet year for the secondaries industry. Five of the market’s most respected players discuss what went wrong and why 2010 will prove different.
For the past two years, the secondaries industry
has been adamant that its big moment is just
around the corner. Indeed, at this very table
a year ago, everyone was convinced we were
on the cusp of an explosion in activity. But
despite this confidence, 2009, in fact, produced
very few sizeable secondaries transactions. Is
that mountain of deal flow finally converting
into completed deals, or is there now an
acceptance that the market misjudged the
scale of the opportunity?
Groen: What we all forgot was that when prices
fall off a cliff, nobody will sell unless they are
desperate. Yes there was a lot of deal flow, but
at the end of the day people won’t sell at 70, 80,
90 or even 100 per cent discounts, unless they
are absolutely forced to. That was the problem.
At those prices there was no way we could get
chAired by amy carroll PhotogrAPhy rIchard Gleed
every second counts
at the table (clockwise, from left) nigel van Zyl sJ BerwinVan Zyl is a partner in SJ Berwin’s private
funds group, as well as advising on secondary
transactions. He joined the firm in 2007.
Marleen Groen Greenpark capitalGroen is principal founder and chief executive
of Greenpark, and has more than 14 years of
global secondaries experience.
oliver Gardey Pomona capitalGardey joined Pomona in 2009 and heads
the firm’s European operations. He has 15
years of private equity experience.
Julian Mash Vision capitalMash founded Vision Capital in 1997 and is
the firm’s chief executive. He has previously
served at H&M Partners and Smith Barney.
david atterbury HarbourVest PartnersAtterbury is principal at Harbourvest, having
joined the firm in 2004. He has led a range
of European secondary transactions.
Sponsored by secondaries
www.realdeals.eu.com REALDEALS 15
secondaries
anywhere near the $130bn (¤92bn) tsunami of
secondaries deals that was being talked about.
and now? What is a realistic estimate of the
size of this potential market?
Groen: I still don’t think its $130bn. But it could
quite easily go back to the $20bn that it was
in 2008. There is a lot of pent-up demand.
Gardey: There are a couple of drivers now that
mean we are going to see the market pick up.
First, there is a lot more visibility on performance,
and a lot more certainty, which means buyers’
appetites have increased and pricing has got
tighter. Equally, on the supply side, sellers can
now afford to sell. If you were a bank being
offered a 50 per cent discount in 2009, you
couldn’t afford to sell because there is a direct
impact on the balance sheet and capital tier-one
ratio. Now, however, the banks have been bailed
out, their balance sheets are stronger and they
are profitable again, so they can afford to sell.
And, of course, the discounts being offered are
lower anyway.
What we have seen in the past two months
is that these supply and demand-side drivers
are coming together and some very large deals
are starting to get done. It is a very
different market from last year.
atterbury: To echo Marleen’s
point, I think pricing got to
such a low point last year
that it wasn’t surprising
that people didn’t
transact. Then, as
Oliver said, as stability
started to return in
the second half of
the year, vendors started to come back to the
market. But inevitably there’s a lead time. It takes
two or three months for those deals to get up
and running, and then another two or three
months to actually get into a process. So we
are now starting to see the conversion of some
of those opportunities in the first half of 2010.
The Bank of America deal, for example, has
been talked about for a long time. The banks
were very patient last year and nobody sold at
the huge discounts we had hoped for. But they
have now reached a point where they
feel there is enough stability for
transactions to take place.
We have seen a couple
of big deals already, and
our expectation is that
there will be more
throughout the year.
$130bn? Probably
not, but a significant
volume of trade.
are the banks also proving a significant source
of deal flow on the direct secondaries side?
Mash: The banks are a major source of
conversations, but not yet a major source of
deal flow. To my mind, though, while I accept the
points being made about the banks stabilising
their balance sheets, the critical driver of why
this flood never happened is actually just interest
rates. The cost of holding an asset that you
strategically do not want to own is low if interest
rates are low, so the penalty for doing nothing is
low, and that will probably remain the case for
quite some time.
So I believe that the transactions that do
get done will be driven by a strategic shift of
some description – rather than prices going
up and down – deals where there is a higher-
level objective, and that’s what we look for.
Our investments at the moment are all about
re-energising companies that have been in limbo
through what we all hope is the bottom of the
cycle, and that are now ready to grow once again.
atterbury: I hear Julian’s point, but I think banks
are in a slightly different position because of the
regulatory pressures they face, which means they
are now prepared to take some level of discount
to achieve their strategic objectives.
as direct investment picks up, and as call downs
proliferate, do you expect to see a second wave
of distressed transactions?
atterbury: In actual fact, we have seen an
increasing level of distribution activity through
the first five months of this year. In our portfolio,
we have probably seen more distributions than
capital calls. Last year we talked a lot about
the pressure on sellers that would result from
increased capital call pace, but that hasn’t really
materialised. It seems firms are selling more
than they are buying, so that pressure hasn’t
really come to bite.
Gardey: The pressures to sell will come from
regulatory and strategic changes rather than
distress. There will be isolated cases involving
family offices and local banks, for example,
that didn’t clean up enough last year. There may
also be some local dynamics, if the situation in
Greece contaminates more of Europe.
But in general, most of the deal flow will be
driven by regulation pressures and portfolio
restructuring. Governments, and the European
Council, are busy talking about what to do about
Basle II framework, increasing capital tier-one
ratios and how to avoid “too big to fail” scenarios
within the financial services industry.
There is also a very strong trend to disallow
or penalise proprietary trading transactions
and ownership of private equity interests on
balance sheets. In addition, insurance companies
are going through a major review regarding
Solvency II. If you talk to a lot of insurance
companies in Europe, most are sitting on their
hands because they don’t want to do anything
in private equity until Solvency II regulation
has been clarified. On top of those regulatory
factors there have been strategic shifts, where
“the amount of money going into private equity as a whole is down, but the secondaries component within that is bigger”
16 REALDEALS 20 May 2010
banks are realising that “pay to play” – investing
in private equity funds in order to get business
from those funds – is not as strategically
important to them as it used to be.
Groen: I would also say that the general portfolio
management that was driving sales in 2005 and
2006 has returned. Ultimately, a lot of secondary
funds have been raised. There is a lot of unspent
capital. Pricing is quite attractive again, discounts
are lower against lower valuations, and there is
a lot more certainty. It is a good time to sell.
Where do discounts currently stand?
Groen: The whole concept of discounts is a red
herring. Valuations at a conservative level would
make a deal at a very small discount potentially
extremely attractive. Equally, aggressive valuations
could make a big discount deal not very
attractive. And that has always been the case.
Mash: I couldn’t agree more with that. In a lot of
our deals there is no NAV. We don’t even know
what the discount might be. We’ve just paid
Palamon 3.7 times their money for Nordax Finans
at a premium to NAV. They are happy and so are
we. Whatever the theoretical discount may be is
completely meaningless, because we are looking
at the future prospects of the business and not
their historical bookkeeping.
atterbury: It may be more appropriate to flip the
concept around, and look at what are our return
expectations on a deal are. I would say that the
market moved to a risk premium to the long-
term average through the first half of last year,
and I think that’s come back down across the
industry. So pricing is probably more consistent
– in terms of our target expectations – with
2007 and 2008 than with the past 18 months.
van Zyl: But for a financial institution seller
going to their board, pricing to current NAV is
helpful because of their accountability to public
shareholders and so on. It is far easier to get a
deal through board approval when the price
offered is nearer to NAV.
Mash: Of course, who wants to take a loss on
a transaction?
Groen: Certainly, a lot of the deals that are
happening this year are the deals that were
all lined up last year, but just didn’t happen
because sellers couldn’t stomach the discount.
Interestingly though, it could well be that a
number of the deals that go through in 2010
will be priced lower, in real terms, than was
offered for the same assets in 2009.
What about the dynamics of the sales process?
over the past 18 months, pricing has been such
that intermediaries have been touting shopping
lists of fund interests to scores of potential
buyers, allowing them to pick off assets one
by one in order to generate the best deal for
the seller. Is that still the case?
van Zyl: Most of the larger transactions that have
taken place this year have been intermediated.
atterbury: But no, those portfolios haven’t been
broken up. With pricing moving up, there is less
of a need to split portfolios up into a thousand
pieces, because buyers are willing to take a little
bit of the good and the bad together in terms
of providing a solution. It is far easier to sell
20 fund interests to one buyer than two fund
interests to ten buyers.
In fact, there aren’t a lot of intermediated
processes on the go at the moment that I am
aware of. Most of our discussions are happening
on a more direct basis. But that said, I am
quite sure we are probably having the same
conversations that other people are having
with the same seller.
The two big deals that have taken place
this year involved that kind of dynamic. Lots
of potential buyers were speaking to those
sellers on a direct basis and the intermediaries
were bypassed.
Gardey: I would slightly disagree, or rather put
another nuance on it. I think deal flow has been
quite bifurcated. Some sellers have felt confident
to run a process on their own, but there are also
transactions where intermediaries are very much
at the forefront. The intermediaries are very busy
right now. These big portfolio sales are efficiently
processed and the pricing is quite high.
and are those types of sales still attracting
the non-traditional secondaries buyers that
dominated the acquisition of single interests,
which were going for a song last year?
Gardey: Yes, it is those large, heavily
intermediated deals where sovereign wealth
funds and big pension funds with large portfolios
feel that, with their access to the GP, they can
price things aggressively. That is why we are
spending a lot of time on sourcing and
origination, particularly looking for small
portfolios where the market is less efficient.
Groen: Certainly, some LPs have started to look
at doing secondaries deals themselves over the
past year or so, but interestingly, we are currently
talking with one investor who now says that their
secondaries activities are giving them – and I
quote – “absolute brain damage”, and they don’t
secondaries
www.realdeals.eu.com REALDEALS 17
want to continue. If you arm yourself with the
proper resources from the start, it may be
possible to come in as a non-specialist on the
more straightforward deals, but if you don’t, it
is very difficult indeed. New players have come
in, of course, and there will be more. But for
a lot of entrants that have been lured by huge
discounts in the last year or so, it just won’t work.
atterbury: It is far easier for a non-specialist to
come in when you have that mosaic effect in the
portfolio. If you have only got to buy four interests,
it is easier to find those interests
you know well and to price
them quickly and comfortably.
That was particularly true
when there was so much
unfunded available in
the marketplace. But if
you have to look at 20
fund interests that are
90 per cent funded
and you are only
invested in half of the names then it’s a lot
tougher. I think the market lent itself to the
sovereign wealth funds last year, but that is less
true now we have the bigger portfolios for sale.
Fund of funds that had not traditionally focused
on secondaries also stepped up their activities
last year. many of these fund of funds now
believe it is easier to raise secondaries money
than primary money, and so are either
increasing their secondaries allocations or
looking to raise dedicated capital.
But is it really still easier to raise
money in this part of the
asset class, or have lPs
lost enthusiasm as the
market has repeatedly
failed to take off?
Mash: You have to look
at the question in the
context of fundraising
as a whole. Yes, there
is a lot of support for secondaries. There is
also a lot of support for differentiation and
performance in general, regardless of the
strategy. But, if you look back to Oliver’s point
earlier, the banks and insurance companies are
disappearing as capital providers altogether.
Those institutions represented something in
the region of a third of all equity going into the
buyout world. The secondaries trades that are
coming to market are just a transition point in
this withdrawal. I don’t think anyone around this
table believes they are coming back any time
soon. These are far more important shifts than
the ebbs and flows of who is fundraising in
what year and with which proposition in mind.
Groen: But even though the amount of money
going into private equity as a whole may be
down, the secondaries component within that
has become much bigger. And it needs to.
Secondaries capital is only two or three per cent
of the primary market. That’s peanuts. All other
primary markets have much bigger secondary
markets than that.
Mash: Yes. The market we are talking about is
a fraction of the size that it rationally should be.
van Zyl: One of your competitors made a
comment the other day saying he thought there
was too much secondaries capital in Europe
chasing too few deals. What do you think?
Gardey: For the plain vanilla transactions
involving well-known buyer groups with well-
publicised information on the portfolio, the
market has become a lot more competitive.
That is a function of a lot of capital being
raised from non-traditional players, as well
as the fund of funds raising their own
secondaries funds, or increasing allocations.
However, those players are not set up to
deal with complex transactions where you
need to spend time understanding the leverage
situation, digging deep into the companies,
direct secondaries, or deals with structural issues.
That’s where our 15 years’ experience in the
secondaries market comes to play.
Groen: I would add that the European market is
really quite different from the US market, not
least because the average LP commitment is far
lower, which means transaction sizes fall below
the radar screens of most intermediaries, who
won’t get out of bed for anything less than
$100m. There are an awful lot of secondaries
transactions in the sub-$50m space.
atterbury: There has really been no change in
terms of the pricing of European deals and the
level of demand. The market for plain vanilla LP
interests has been highly competitive for the last
six or seven years – going back to the previous
boom and bust. On a relative basis, it has
consistently felt more competitive, pricing-wise,
for quality European names than for US names.
That is a function of the history of the market.
It is not as mature as the US.
Groen: There are also significant cultural and
linguistic differences between the two markets.
We are obviously a patchwork of cultures and
languages, and therefore it will be far more difficult
secondaries
“in the past two months, supply and demand-side drivers have come together and some large deals are getting done”
www.realdeals.eu.com REALDEALS 19
secondaries
– and I personally think impossible – for Europe
to ever become as efficient a market as the US.
Gardey: But the market is evolving nonetheless.
Julian was a pioneer of the whole direct
secondaries market in Europe, and we have seen
other niches where we, as a firm, are preparing
to set up dedicated funds and even dedicated
teams. For example, we see a great opportunity
in the secondaries co-investment space.
There has been a lot of co-investment done
over the past six or seven years, but traditionally,
secondaries players haven’t liked to buy single
assets. We see a real opportunity there.
Another area is energy. The energy market has
experienced great growth over the last five or six
years, but energy deals require a very different
mindset when it comes to due diligence and
understanding the teams. Very often, there is also
a strong regulatory component. We see a lot of
scope for increasing specialisation in secondaries.
last year, secondaries houses claimed that direct
secondaries deals were becoming, relatively
speaking, less attractive as the risk premium
on traditional lP secondaries increased.
have direct secondaries deals become more
attractive again, now that the pricing of lP
interest deals has become more competitive?
atterbury: It is true that last year we were hoping
there would still be opportunities to do fund
interest deals with our sense of the market risk
premium built in, and therefore to get those
deals done at very attractive discounts. If it
is possible to price an LP interest deal at the
same rate as a direct portfolio, then why take
the incremental risk? That didn’t necessarily
materialise, of course. The differential in returns
has gone back as the LP market has moved down
to more normalised long-term targeted returns.
That said, we have always been active in LP
interest and direct deals. We didn’t complete
on either in the first half of last year. Now we
are back closing on both.
how have the competitive dynamics of the
direct secondaries market evolved?
Mash: The market is becoming more competitive,
which is actually quite healthy. But what we really
compete against are alternative forms of sale. We
compete indirectly with the whole array of capital
and M&A markets. That is the most important form
of competition, because sellers are infrequently
distressed but often strategic. They do have
choices and we must provide better value.
and from the perspective of secondaries houses
that are providing the capital for these deals,
is the overall quality of “GP for hire” improving?
Groen: There are still very few GP-for-hire teams
that have built real track records. Many groups
never really get off the ground.
might we see direct investment GP teams that
are struggling to raise their own funds heading
down the GP-for-hire route?
Groen: A lot of GPs are trying to figure out how
to stay in business full stop. GPs don’t disappear.
Or if they do, they don’t disappear very
quickly. But at the same time, a lot of
GPs know that they will probably
not raise another fund, and
so they are trying to figure
out annex vehicles and
other structures to
enable them to keep
going. That is where
the more experienced
secondaries houses
can come in.
In these scenarios
– indeed in all
secondaries scenarios
in a market such as this,
where a large number of
GPs are unlikely to be able
to raise again – assessing the
quality of the GP franchise must
be more important than ever.
Groen: Absolutely. You need to figure out if
a GP with reducing management fees – as its
funds mature and without a new fund – is going
to milk the investee companies for additional
fees where he can, or if a GP is actually going
to do the right thing by his investors.
atterbury: The good thing is that we are
obviously 12 months on and there is more
visibility of performance of the underlying
operating companies. There is also more visibility
in terms of the team and future fundraising
prospects – where is the unfunded going to
go? Is it going to be used to support poorly
performing existing companies? Are they looking
for new deals? Is the investment period getting
close to terminating? And because there is more
visibility, you can price slightly more aggressively
around some realistic assumptions.
Gardey: I think it is also important to recognise
that the unfunded can actually be a great thing, if
you like the GP and if they have been disciplined.
Most deals done in 2006 and 2007 were done at
very high prices, and so the unfunded can give
you extra balance in a portfolio.
What about the acquisition of legacy portfolios
from GPs. 3i has obviously completed a number
of such deals, and Julian, you have also been
involved in similar transactions with a handful
of other buyout houses. But in general, do
private equity houses remain resistant to
the idea, or have unprecedented fundraising
pressures finally unblocked the dam?
Mash: We have lots of deals in our sights at the
moment involving buying what is left in fund one
and fund two, so that the GP can focus on fund
“new players have come in, and there will be more. But for a lot of those lured by discounts in the last year, it just won’t work”
20 REALDEALS 20 May 2010
three and raise fund four, for example. Those are
very good deals because companies in old funds
don’t have ready access to capital, which is
something we can provide them with.
And of course, these deals have a broader
relevance for fundraising. GPs may get stuck
for a long time, but ultimately, any private equity
houses that can’t raise new capital will go out
of business, however long it takes. Coming up
with creative structures that can help clarify a
firm’s future strategy or deal with succession,
anything that can enable a firm to move forward,
is incredibly valuable.
atterbury: Nevertheless, you need to be a pretty
enlightened GP to take that course of action.
We have been pushing this type of deal for some
time but if anything, GPs that are fearful of not
being able to fundraise cling even more tightly
on to their portfolios. It is often those portfolios
that are in need of a fresh team. I don’t think
this is ever going to be a huge market.
Mash: In reality, it tends to be the successful
and good-quality firms that are more willing
to innovate, and those are the teams we
are targeting in any case. If you are in that
dreadful rut of having no carry from your
current fund and being unlikely to ever raise
another, that creates all sorts of conflicts.
There are all kinds of unintended consequences
in the way that the economics of private equity
funds work. It all works fantastically well on
the upside, but there are a lot of conflicts on
the way down.
Groen: I would say though that GPs are more
reluctant to do these deals than their LPs are.
Ask any LP and they would love to get
liquidity from their older funds.
But ask any GP, and they’re
adamant that LPs would
object.
atterbury: What we are
seeing is some of our
GPs now actively
looking at their roster
of LPs and
approaching those
that they don’t think will be investing in their next
fund, then working with us to see if there is a way
we can approach those LPs. In other words, they
are proactively managing their LP base in
advance of a future fundraising.
Gardey: Certainly, GPs have become much more
focused on LP relationships. They are hiring
internal IR functions if they didn’t previously
have them, and they are focusing more on LP
communication, which means they understand
far better who is a potential seller. At some of
the bigger firms, when a secondaries transaction
comes up, an internal online marketplace will
be set up to match sellers with buyers. That is
an indication of how much more sophisticated
the communication has become.
There have been several attempts to fully
automate the secondaries market over the
years. could that ever really work?
Groen: There are people who have been working
on this for years and years, but for anything
other than the most basic LP interest trade,
automation just isn’t possible.
van Zyl: Ultimately, third-party consent is
required. You can matchmake as much as
you like, but the deal is still at the discretion
of the GP.
Mash: That type of automation doesn’t even
really work on the high-yield bond market.
While secondaries houses have been quick
to emphasise their countercyclical nature and
the opportunity the financial crisis presents
for the industry, top of the market secondaries
portfolios have been hit hard. how severe are
these portfolio problems, and might we see
some secondaries houses disappearing as
many now expect primary firms to disappear?
Gardey: More than anything, what we will see
is more specialisation. We now have direct
secondaries firms, there are also firms focusing
on venture, on mezzanine, and there are firms
like Pomona that focus more on the mid-market.
That trend will continue. But where we do
anticipate some consolidation is among the
fund of funds and non-traditional secondaries
players that have wandered into the market.
atterbury: My view is that there will be some
poor performers from 2006 and 2007 vintages,
and that could create a knock-on effect when
it comes to raising future funds. Yes, the market
is growing and evolving, but there is no doubt
some groups will be challenged and that
fundraising will be incredibly tough.
and can you guarantee that this
time next year, we won’t still
be asking whether the
secondaries market is
finally going to take off?
atterbury: I can say
with some confidence
that we expect 2010
to be the year of the
secondary.
secondaries
“we really compete against alternative forms of sale. sellers are infrequently distressed but often strategic. they have choices and we must provide better value”