Secondary Pricing Trends & Analysis, July 2013 Secondary Market Volume Declines Despite Increased Pricing and Demand
Secondary Pricing Trends & Analysis, July 2013 1 Secondary Pricing Trends & Analysis, July 2013 Secondary Market Volume Declines Despite Increased Pricing and Demand Executive Summary In a reversal from the busy fi rst halves of 2011 and 2012, the fi rst half of 2013 marked the lowest level of secondary market activity since 2009. Cogent estimates that while fi rst half volume in both 2011 and 2012 was approximately $13 billion, transaction volume in the fi rst half of 2013 was approximately $7 billion. Many market participants had expected a busy start to 2013 following resolution of the uncertainty surrounding the U.S. presidential election in November and fi scal cliff discussions in December, particularly when viewed in conjunction with strong global equity markets entering 2013. However, secondary market volume was anything but robust due to several factors, including the concurrent rise in public markets and healthy distribution activity from private equity portfolios that began in late 2012. These factors caused many would-be sellers to postpone potential transactions during the fi rst half of 2013. One dynamic that did not contribute to lower volume was secondary pricing. The average fi rst round high bid for all funds was 84% of NAV (Net Asset Value), refl ecting an increase of over 4 percentage points of NAV from 2H 2012 to 1H 2013, driven largely by buyout funds, which received an average high bid of 89%, the highest level in over two years. Furthermore, second round pricing exceeded fi rst round levels by approximately 3% of NAV, refl ecting healthy and improving market conditions and demonstrating the value of a competitive and wellmanaged transaction process. This rise in price occurred in spite of the fact that NAVs also increased on average during 1H 2013 and that the overall quality of funds in the market declined slightly in 1H 2013 versus 2H 2012. In light of this lower market volume, sellers have been able to get buyers attention on funds that would likely have been overlooked in 2012. With NAVs rising and secondary buyers actively seeking to deploy more than $35 billion of dry powder, current market conditions have been nearly ideal for potential sellers. The question therefore remains: how long will this seller-favorable window remain open? The analysis in this paper examines the key pricing and volume trends observed during 1H 2013 as well as our expectations for the remainder of the year. The major fi ndings include: 1. The average high fi rst round bid for all funds increased to 84% of NAV in 1H 2013 from 80% of NAV in 2H 2012 and was once again led by buyout funds, which received average high pricing of 89% of NAV. As noted previously, second round pricing exceeded these levels by approximately 3% of NAV due to the increased competition associated with a formal transaction process. The rise in overall pricing is not surprising given the increase in public equity prices during 1H 2013, combined with the lack of secondary supply, which has led some buyers to be more aggressive with their bids. Consistent with prior periods, there were wide disparities in pricing across strategies. However, pricing for all strategies including venture saw an increase during the fi rst half of 2013. 2. Despite higher pricing, 1H 2013 marked the lowest half-year market volume since 2009, which came as a surprise to most market participants. Although 1H 2013 volume of $7 billion was approximately half the volume seen during the fi rst half of both 2011 and 2012, an analysis of the market activity reveals that the decline in the number of sellers is not nearly as dramatic. Therefore, rather than being a refl ection on the health or stability of the secondary market, the decline in volume in 1H 2013 is more a function of the type of sellers in the market and more specifi cally, fewer public pensions and fi nancial institutions executing $1 billion+ transactions. 3. As we noted at the end of 2012, selling activity by fi nancial institutions slowed markedly in 4Q 2012 and this trend continued into 2013. While public pensions and fi nancial institutions (including insurance companies) dominated secondary volume in 2011 and 2012, Cogent estimates that these two categories of investors accounted for approximately 25% of the sellers in 1H 2013, down from nearly 50% of the sellers by number in 2H 2012. At the same time, selling by
2 Secondary Pricing Trends & Analysis, July 2013 Fig. 1 Secondary Pricing Over Time 100% 90% 83% 86% 89% 89% 84% 83% 83% 86% 80% 70% 61% 72% 80% 84% 85% 81% 80% 80% 84% 60% 50% 40% 30% 40% H1 2009 H2 2009 H1 2010 H2 2010 H1 2011 H2 2011 H1 2012 H2 2012 H1 2013 Avg. High % Exposure (NAV plus unfunded) Avg. High % NAV Source: Cogent Partners other categories of limited partners has increased, primarily due to the attractive pricing levels that have resulted in certain sellers pursuing opportunistic sales to capitalize on the seller-favorable market conditions. As a result, the universe of sellers was as balanced as it has been in several years, with 5 different categories of investors comprising between 12.5% - 17% of sellers by number and no single investor type comprising over 20%. 4. While the sale of limited partnership interests in the secondary market by traditional LPs slowed in 1H 2013, transaction activity from GPs continues to rise. Specifi cally, growth in the number and volume of GP-led secondary transactions (such as fund recapitalizations or wind-downs) is accelerating. In aggregate, GPs and fund-of-fund managers comprised approximately 40% of 1H 2013 transaction volume by value. As many funds raised in the late 1990s and early 2000s approach or extend past the end of their fi nite terms, managers are now increasingly proactive with respect to alternative liquidity methods that both alleviate timing pressure and expedite the return of capital to their investors. Data Sample and Methodology This study analyzes the bids that Cogent Partners received on a diverse group of partnership interests marketed from January through June 2013. The funds marketed represent a range of fund types, driven once again by a large share of buyout funds (54% buyout funds, 29% venture funds, 10% mezzanine and distressed debt and 7% other funds including a range of real estate, energy and infrastructure strategies). As always, the bids represent fi rst-round bids, though the pricing at which sellers ultimately transacted was approximately 3% of NAV higher on average than the fi rst round bids analyzed in this report. Consistent with the methodology used in previous pricing studies, in cases where bidders submitted a pricing range in lieu of a single price, the midpoint of the range was used in the analysis. Overall Pricing Increases Across All Strategies; Driven by Public Market Rally and Record Dry Powder Secondary pricing as a percent of NAV increased by approximately 4 percentage points in 1H 2013 for all strategies in aggregate. For funds marketed in 1H 2013, the average high bid (refl ecting the simple average of the highest bid received for each asset) was 84% of reported NAV, as compared to 80% in the second half of 2012 (Figure 1). While the composition of secondary market supply refl ects a diverse mix of underlying investment strategies, pricing (and volume) was once again driven by buyout funds which received an average high bid
Secondary Pricing Trends & Analysis, July 2013 3 Fig. 2 Buyout Pricing Bid Dispersion 30% 27% 25% 20% 20% 22% 15% 10% 5% 4% 4% 6% 8% 10% 0% < 70% 70% - 74% 75% - 79% 80% - 84% 85% - 89% 90% - 94% 95% - 99% 100% % of NAV Source: Cogent Partners of 89% of NAV versus 84% in 2H 2012. Venture pricing also continued its upward trend, with an average high bid of 77%, up from 70% and 74% in 2H and 1H 2012, respectively. The relatively tight range of average high bids since 2010 may lead the casual observer to believe we are trending towards a more effi cient market, but this is far from the case. We continue to witness a broad range of pricing dispersion for both specifi c funds and investment strategies. In 1H 2013, the spread between the average high bid and low bid per fund was over 20% of NAV, which is consistent with levels we have tracked for the past several years. As a result, despite the maturation of the secondary market, sellers may often achieve a sale price that is over 10 percent higher by transacting with the high bidder versus the average bidder. Further, while the average high bid for buyout strategies was 89% of NAV, nearly 60% of all buyout funds marketed by Cogent in 1H 2013 priced above this level (Figure 2). Conversely, just 14% of all buyout funds priced below 80% of NAV. The secondary market has long been characterized by an element of ineffi ciency which continues to persist despite increased capital and competition, more transparent and better fund reporting and the widespread adoption of fair market value accounting standards. This dynamic continues to present a compelling opportunity for sellers to craft portfolios that meet specifi c pricing objectives, provided a competitive and thoughtful marketing process is utilized. While secondary pricing is ultimately driven by manager quality and perception, fundamental return prospects at the underlying asset level and portfolio company valuation methodology, it is highly correlated with broader public equity market performance. In the fi rst half of 2013, global equity markets were highly volatile particularly in isolated European economies and emerging markets (namely China) and against a broader backdrop of macroeconomic uncertainty concerning the timing and impact of QE2 tapering. However, improving fundamentals in the US and other developed markets, which serve as a proxy for the vast majority of secondary market supply, contributed to strong public market performance in 1H 2013. During this period, the S&P 500 appreciated over 13% (10% of which came in Q1) which marked its best half since H2 2010, while the Stoxx Europe 600 index appreciated approximately 2%. As we would expect, secondary market buyers factored this growth, along with a generally favorable near to midterm economic outlook, into their pricing. Interestingly, secondary market pricing was relatively consistent across North America, Europe and Asia focused funds. One possible explanation for this phenomenon is the emergence of secondary buyers with specifi c geographic preferences that have the local relationships, experience and investment personnel to quickly and effi ciently diligence opportunities in specifi c regions. In addition to generally strong fundamental performance and an increase in public market comparables, secondary market pricing in 1H 2013 benefi tted from a favorable supply / demand dynamic. According to
4 Secondary Pricing Trends & Analysis, July 2013 Fig. 3 Secondary Market Seller Universe in 2013 Number of Sellers Transaction Value Other 17% Financial Institution 17% Superannuation Fund 10% Other 2% Financial Institution 17% Superannuation Fund 8% Public Pension 8% General Partner 13% Public Pension 26% Family Office 13% Endowment 13% Fund-of-Funds 13% Family Office 3% Endowment 2% Fund-of-Funds 7% General Partner 33% Source: Cogent Partners and publicly-disclosed information Preqin, over the past 18 months, 39 secondary funds have held fi nal closings on funds with total capitalization of over $36 billion. Furthermore, Cogent estimates there is currently over $35 billion of equity capital earmarked for secondary acquisitions plus several billion in additional third party acquisition fi nancing available from a mix of traditional and non-traditional lenders. This record level of dry powder coupled with relatively low transaction volume in 1H contributed to an enhanced competitive dynamic that served to boost secondary market pricing. Temporary Slowdown in Volume Despite Favorable Pricing Dynamic Secondary transaction volume fell to $7 billion in 1H 2013, refl ecting the lowest half-year volume since the depths of the fi nancial crisis in 2009. While the prior market lull was driven by pervasive uncertainty, volatility and a host of systemic economic issues which contributed to historically low pricing, the slowdown in 1H 2013 appears to stem from the temporary confl uence of the following factors: Regulatory Delays: Government regulators in the US have still not fi nalized the full implementation guidelines of Dodd-Frank, which prohibits US banks from holding third party fund investments past July 2014 (among many other restrictions). While numerous institutions have brought portfolios to market over the past two years in anticipation of the new regulations, the majority of US banks that continue to hold affected assets are taking a wait and see approach and opting to review the fi nal regulations before deciding on the appropriate course of action with respect to disposing of their alternative asset portfolios. Strong Public Market Performance ( Numerator Effect ): Certain investors, namely public pensions and other investors that adhere to strict asset allocation policies, were suddenly relieved of outsized PE allocations as public equity market gains outpaced private equity NAV write-ups and re-investment. As such, very few sellers moved to market in 1H 2013 to reroute illiquid exposure to other asset classes. Time Lag in PE Reporting: In the midst of a broader public market rally in Q1, as well as strong performance in many PE portfolios, many LPs were hesitant to transact off of stale NAVs (September 30, 2012 or December 31, 2012) before they received full visibility into write-ups at the end of Q1. While competitive secondary buyers factor such good news into their pricing, some LPs simply required a complete understanding of their new NAVs before a decision could be reached. Distribution Activity: Distribution activity in Q4 2012 and Q1 2013 was exceptionally high for many LPs across investment strategies. Further, there has been a signifi cant increase in recapitalizations / refi nancings in 1H 2013 by GPs seeking to take advantage of an attractive interest rate window that appears to be closing. The result has been that certain LPs have sought to hold funds in the near term to capture the full value of these
Secondary Pricing Trends & Analysis, July 2013 5 Fig. 4 RVPI for 10+ Year Old Funds 0.60x 0.50x 0.42x 0.46x 0.50x RVPI Multiple 0.40x 0.30x 0.20x 0.21x 0.15x 0.15x 0.25x 0.36x 0.35x 0.10x 0.13x 0.13x 0.00x 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Year Source: Preqin distributions prior to commencing a sale. As noted above, we believe the recent slowdown in secondary transaction activity is only temporary. Given the signifi cant amount of secondary capital raised to date, the large number of investors with legacy and / or allocation issues and an increasing tendency for LPs to actively manage their illiquid portfolios, we project an uptick in transaction activity over the near-term to levels seen over the last few years. Highly Diverse Group of Seller Types; GPs and FOFs Emerge as Key Players In spite of the decreased transaction volume in 1H 2013, an analysis of both the seller type and profi le of secondary market supply yields insight into emerging trends that will impact near-term transaction activity. Public pensions and fi nancial institutions represented over 50% of secondary supply in 2012 by number of sellers and dollar volume, yet comprised just 25% of secondary sales by number and 42% by volume in the fi rst half of 2013 (Figure 3). Cogent believes that fewer than fi ve pension deals were completed in 1H 2013, one of which was a $1 billion structured transaction that represented the vast majority of YTD pension dollar volume. With respect to fi nancial institutions, nearly all of the 1H transactions were completed by European or Asian institutions as opposed to the US banking entities that contributed to meaningful supply in 2011 and 2012 in response to Dodd-Frank and other pressures resulting from the fallout of the fi nancial crisis. One notable theme to emerge in 1H 2013 was the prevalence of GP-led secondary transactions as sponsors of both direct funds and fund-of-funds accessed the market to pursue a range of objectives. Cogent has witnessed a clear trend of LPs selling very mature, legacy exposure over the past few years and it is clear that this tail-end burden is beginning to shift from LP to GP, as many funds have extended well past their intended 10- year terms. In aggregate, GPs (including fund-of-fund managers) represented over 25% of 1H 2013 secondary supply by number and 40% by dollar volume as compared to nominal volume over the past few years. Unlike traditional LP sales that are often prompted by portfolio management initiatives, GP-led secondary transactions are generally less infl uenced by current market conditions or an attempt at portfolio optimization. Rather, they are conducted in response to timing pressure relative to fund terms or to effect a strategic change at the management company level. Due to challenging economic conditions and related diffi culties in growing and exiting investments over the past fi ve years, many sponsors that raised funds in the late 1990s and early 2000s continue to hold much larger exposures towards the end of, or well past, their intended 10-year terms. In fact, according to Preqin data, in 2012 the average 10-year old fund in 2012 had an RVPI multiple (NAV divided by cumulative amounts paid-in) of
6 Secondary Pricing Trends & Analysis, July 2013 0.5x, over twice that of 10-year old funds in 2005-2007 (Figure 4). The secondary market offers sponsors the opportunity to wind-down tail-end vehicles as opposed to pursuing the piecemeal sale of each remaining asset, which often results in escrows and retained liabilities that can further delay a fund s termination. Additionally, certain sponsors have also elected to restructure existing funds whereby a new vehicle is formed to acquire either the existing LP interests or the underlying portfolio company securities in addition to potentially including capital for new investments. This solution provides electing LPs the option for liquidity and the sponsor with additional time to manage the portfolio and potentially new primary capital to bridge the gap before a new fundraise is possible. Such processes are bespoke by nature and far more complex than the traditional LP sale; as such, experienced advisors with deep secondary market relationships are often required to ensure a fair and favorable outcome for all counterparties. and an emerging crop of sophisticated secondary market buyers are now able to provide fl exible and creative solutions to LPs as well as GPs that address issues with respect to exit timing, performance and alignment of incentives within mature fund vehicles. As transaction activity increases in the second half of 2013, and in light of an increasingly diverse number of issues confronting both LPs and GPs, sellers should be fully aware of current and projected market conditions before launching a transaction. An experienced secondary market advisor can provide investors with real-time capital markets insight, execute optimal marketing strategies and provide better access to the most appropriate buyers for a given transaction in order to both maximize pricing and best meet sellers objectives. What Lies Ahead for the Remainder of 2013 As we look forward to the second half of 2013, there are a few themes that Cogent expects to factor into the market in the coming months, including: Uptick in Transaction Activity: In light of substantial available secondary investment capital, strong pricing conditions and numerous portfolio management and regulatory objectives currently confronting LPs, we project a considerable increase in secondary transaction volume in the second half of 2013. Based on these factors and our current pipeline, we project full year 2013 volume of $18-20 billion. LPs contemplating a transaction will be well served to consider the current and near-term market pipeline and position portfolios accordingly in order to receive maximum interest and pricing. Opportunistic, Sophisticated LPs Simultaneously Buying and Selling: As the secondary market matures, sophisticated LPs are increasingly knowledgeable regarding market dynamics and transaction processes. This has provided numerous institutions with the comfort to access the market as both buyer and seller in a given time period in order to proactively manage their investment portfolios. While we do not believe such parties will necessarily adopt a trading mentality, we do believe savvy LPs will take the necessary steps to modify internal processes in order to more effi ciently respond to secondary market opportunities as both a buyer and seller. Additional GP Transactions: The secondary market has continually evolved to meet the primary objectives of institutional investors. Leading secondary market advisors
Cogent Partners has advised institutional investors on approximately $75 billion of private equity secondary transactions since the firm s founding. Through its research-driven, analytical approach to the secondary market, Cogent Partners assists institutional investors in achieving their objectives and fulfilling their fiduciary duties. If you are interested in a confi dential discussion of your alternative asset portfolio, including detailed insight into pricing for assets you would consider selling or ideas on other avenues to generate liquidity, please don t hesitate to contact us. All conversations are held in the strictest confidence. Dallas 2101 Cedar Springs Road Suite 1200 Dallas, TX 75201 Tel: 214.871.5400 Fax: 214.871.5401 New York 599 Lexington Avenue Suite 3810 New York, NY 10022 Tel: 646.274.4950 Fax: 646.274.4951 San Francisco 1 Market Street Spear Tower, 36th Floor San Francisco, CA 94105 Tel: 415.293.8044 Fax: 415.293.8045 London 6th Floor, 6-8 Tokenhouse Yard London EC2R 7AS Tel: +44 207 260 1830 Fax: +44 207 260 1831 Shanghai 8 Century Avenue 36F Two IFC, Suite 3636-3637 Shanghai, China 200120 Tel: +86 21 6062 6128 Fax: +86 21 6062 6399 www.cogent-partners.com Disclaimer: Aggregate pricing data disclosed herein is not appropriate for the valuation of individual fund interests. Should you require a valuation of a specifi c fund interest, please contact us.