It can be difficult to make sense of the social, economic, and financial disruption unfolding in response to the spread of the novel coronavirus, otherwise known as Covid-19. What is certain is that stock markets have tanked by circa 25% over the past month, with some of the largest single-day drops in history. This has obvious implications for the valuation of private equity assets and will need to be woven into pricing calculations in the secondary market.
In the coming days, LPs will begin to receive their NAV calculations from GPs. The first thing to note is that these will be considerably off the mark since they will apply to asset valuations from last year’s Q4 quarter-end at the very latest.
Those invested in Chinese PE funds might see the early impacts coronavirus has had, given that the outbreak started at the beginning of December 2019. Even in China, however, the full effect of the pandemic will not be reflected in imminent PE valuations. Inevitable write-downs are yet to come.
Another thing to consider is that there is no strict standard for portfolio reporting. Some managers may offer guidance on where they expect to see or already observe, weaknesses within the portfolio. LPs may choose to have direct conversations with their managers to gain deeper insight as to where the portfolio’s NAV is likely to sit as of today, with the last month’s stock market rout taken into account.
To gain a steer on valuations, it can be useful for sellers to take an independent, ad hoc approach. The primary method GPs follow is to mark their assets to publicly listed equivalents. So sellers looking to unlock liquidity should look at a basket of the closest public comps available and divide these companies’ respective market capitalizations by their earnings. This will give a series of price-to-earnings ratios that can be averaged out, leaving a multiple that can be transposed onto the private company in question. It’s important to remember here that, unlike the enterprise value metric used throughout private equity, public market capitalizations do not account for debt.
Sellers can also look to recent deal activity to estimate price multiples, the problem here being that M&A will have evaporated in recent weeks and so any transactions will not reflect the coronavirus outbreak.
Incorporating discounted cash-flows into calculations may also offer clues as to the fair value of assets, but this may also be the most limited input of all at this point in time. The odds of a US recession are now hovering at just above 50%. Predicting EBITDA run rates of portfolio companies is challenging at the best of times and even more so now that the economic growth trajectory hangs in the balance.
Private equity valuation methods are far from an exact science, and public market comping has its limitations. But, despite the margin for subjectivity, such proxies can guide investors. It is incumbent upon both buyers and sellers in this market to be more proactive than ever in their approach to NAV calculations and in estimating the price bids that follow from these estimates.
Naturally, what we are seeing now is a pause in secondary sales coming to market as investors get their bearings on the market, given the greater volatility of late. During this break, we are seeing an increased number of investors assessing the secondaries market as they begin to address the new market realities. At Palico, we’ve seen a 50% increase in the number of inbound calls, over the past two weeks, by market participants wanting to learn about their various liquidity options. Sellers can know for sure what the market believes is the fair price of their fund interests by listing them on Palico, with no obligation to sell. But pre-empting this bidding stage with some analysis may help in managing expectations.
As always, stay safe and well out there. Do not hesitate to contact us with any questions or insights you’d like us to explore or discuss – you can reach me directly by replying to this email or at christopher.jeffery@palico.com.
