Price can make or break a secondary deal. In the good old days of 2019 it was not uncommon to see fund positions trading at premiums to net asset value (NAV). Such was the demand for PE assets that buyers were willing to pay over the odds, betting on further appreciation for the acquired funds' portfolio companies. This time last year we estimated that the average secondary deal price was above par, only the third time this has happened in the history of the secondary market and a continuation of the two previous years. • 5 min. Read •
Then came the annus horribilis of 2020, with its global pandemic and nationwide lockdowns. One might have expected secondary bids to fall substantially amid the uncertainty surrounding coronavirus and the economic turmoil it has been inflicting. But, somewhat counterintuitively, there is a counterargument to this.
Recently eFront, the data publisher owned by BlackRock, attempted to predict the impact of coronavirus on different PE vintages, using the global financial crisis as a benchmark. It found that funds raised in 2016, 2017 and to a lesser extent 2018 will likely suffer the most, assuming the worst of the pandemic crisis will be in 2020. The 2016-17 pressure point comes from the fact that these funds are old enough to be close to fully invested but not old enough to have benefited much from the conducive exit environment before the coronavirus struck.
One especially compelling observation from the report is the resiliency of PE NAVs relative to stock markets. Plenty of academic research has attempted to determine the correlation between public and private market valuations. While there is a margin for interpretation as to how closely these assets correlate, when stocks fall PE assets usually follow.
eFront notes, however, that PE NAVs do not fall as much as stock markets. One reason for this is that, unlike indexes, which simply hold the market, GPs are constantly buying and selling. As such, despite existing portfolio companies losing value when markets are sour, having capital to invest means that GPs are able to capitalize by acquiring companies at attractive prices. This results in PE NAV depreciation being short-lived and fund valuations holding up better than the public market, despite the value of existing portfolio companies held by the fund suffering.
By replacing an outgoing LP in a fund, the incoming LP in a secondary trade also assumes the unfunded portion of the fund — and at par since a dollar is always worth a dollar. Except that, in periods where valuations have eased off, a dollar buys more of a company's equity. This could be described as the “dry powder potential” of PE fund's undrawn capital.
So, while pushing for a premium-to-NAV might be a stretch at this time, the age of the fund can make all the difference when assessing discounts, especially when presented with steeper ones.
Typically the younger the fund, the greater majority of capital it has left to deploy (depending on how acquisitive it has been). And the more undrawn capital that is available to a GP while asset prices are low, the more bargaining power a seller has to negotiate on the price-to-NAV of the invested portion of the fund. Why? Because the fund has a greater dry powder potential than a fund with less uninvested capital.
Buyers of 2019 fund positions, then, are essentially stocking up on what is likely to be a premium vintage. For the right manager, the price of that access might not need to come at such a heavy discount after all.
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