Secondaries investors have been expanding their horizons lately.
“We have people with M&A experience, legal experience, portfolio company operational experience [and] complex secondaries experience,” a managing director at a top 15 secondaries house tells sister publication Private Equity International. “You’ve seen a massive upgrade in the skills sets of all teams.”
Looking at the range of deal types and structures that have proliferated in the secondaries market in recent years, it’s clear personnel is not the only thing that’s become more diverse.
It’s difficult to say which is the tail and which is the dog. Has a booming secondaries market attracted a broader range of people, who are employing their own experiences to drive greater innovation? Or has the need for secondaries firms to stand out in an increasingly competitive market caused them to think more creatively about what they do and who they employ to do it? Either way, the fundamental definition of private equity secondaries has changed and continues to change at a rapid pace.
Take single-asset restructurings, which seem anathema to the principle of diversification that the LP stake-sale market was founded on. These deals are typically employed in situations where one asset in a portfolio requires extra time or capital to reach maximum value and not all limited partners want to stick around. The asset is removed from the fund and placed in a separate, shorter duration vehicle managed by the same GP but backed by fresh capital. Given the diminished size of the new vehicle and shorter return profile, the terms are typically a 1 percent management fee and 10 percent carried interest, or something similar, as opposed to the usual two-and-20.
These deals have exploded in popularity over the past 18 months. According to research by advisor Campbell Lutyens, the average secondaries buyer made between three and four of these highly concentrated bets in 2017. Brand-name managers such as PAI Partners, TDR Capital and Lime Rock Partners are among those to have carried out single-asset restructurings in the past few months.
There are several reasons for the increase in popularity. For a start, the average price of buyout funds trading on the secondaries market hit 98 percent of net asset value at the end of the first half of 2018, according to data from secondaries advisor Greenhill. This was driven by the proliferation of leverage. Those that don’t want to pay a hefty premium have to look away from conventional portfolio acquisitions to more complex or concentrated deals. And if a GP thinks there is eventual upside in that remaining asset, it makes sense to hold on to it.
At the same time, it’s no coincidence that many early adopters were buyers with broad co-investment or direct investment capabilities, such as Goldman Sachs, which realised the benefits of bringing to the secondaries market a more granular, M&A-like approach to due diligence.
Patrick Knechtli, head of secondaries at Aberdeen Standard, describes the process, which would probably seem very strange to the earliest secondaries players: “You will do your own independent analysis, you’ll meet with the management of the underlying company and in some cases the secondary buyer engages external advisors [and] management consultants, who will do work on the company and the market it is operating in.”
A number of brand-name single-asset restructurings have been mooted or closed in the past year. In July, TDR Capital carried out a process on its €2.1 billion, 2007-vintage third fund, hoping to give more life to the last remaining asset. It lifted UK-headquartered Stonegate Pubs from the fund into a new vehicle backed by secondaries buyers, one of which was Landmark Partners, as sister publication Secondaries Investor revealed.
PAI Partners has been exploring a similar process, seeking to transfer the last asset in its €2.69 billion, 2005-vintage fourth fund into a continuation vehicle backed by a syndicate of secondaries buyers. Malmo, Sweden-headquartered chemicals maker Perstorp was valued at SKr9.2 billion ($1 billion; €873 million) at the time of acquisition in 2005. The deal was being sized up by investors at press time, with Landmark Partners again closely linked.
Stay tuned for part II of this feature.