Buyers rethink deployment strategies amid market imbalance: Greenhill Cogent

Average deal sizes have almost halved in the last two years and buyers are purchasing assets across strategies and vintages they have not historically considered, according to the advisory firm.

The secondaries market is experiencing a “moderate supply and demand imbalance” with deployment pressure and lower deal volume leading to higher pricing for sellers, which in turn forces buyers to change tack, according to Greenhill Cogent.

Deal volume fell almost 8 percent to $37 billion last year, down from $40 billion a year earlier, according to the advisory firm’s Secondary Market Trends & Outlook, January 2017. Only five transactions larger than $1 billion – defined as purchase price plus unfunded commitments – closed during the period, compared with eight in 2015.

Coupled with the more than $110 billion available in dry powder, these market dynamics are resulting in buyers underwriting to lower returns and bidding more aggressively, and being pushed to purchase assets across strategies and vintages they have not historically considered, the firm wrote. This trend is expected to continue into 2017, the report noted.

Buyers have had to reconsider their deployment strategies amid increasingly competitive conditions, Wes Bender, a principal at the firm, told Secondaries Investor.

“Many buyers have lowered their minimum bite-sizes over time, realising that they can’t solely rely on large portfolio deals to reach their annual deployment targets,” Bender said. “During periods in which these larger deals are less prevalent, such as 2016, buyers tend to focus on acquisitions of single interests or smaller fund portfolios to keep pace.”

Fewer deals over $1 billion, more tail-end funds with lower net asset value and sellers using the market more frequently for smaller disposals resulted in the average deal size almost halving to under $180 million, compared with around $300 million in 2014. The firm notes the figures are derived from deals on which it has advised.

While average high bids slipped 1 percentage point to 89 percent of net asset value across all strategies, buyout and venture funds rose, with 1 percentage point and 3 percentage point gains, respectively. The firm attributes the rise in buyout pricing – to 95 percent from 94 percent of NAV – to strong demand for 2010 to 2015 vintage funds, with some buyers bidding at double digit premiums for stakes in such vehicles.

Higher quality venture assets and stable public markets were some of the drivers that pushed pricing for venture funds to 78 percent from 75 percent of NAV, the firm wrote. Lower exposure to unicorns in venture funds last year also contributed to the pricing boost: buyers tend to see such investments as having limited potential upside and may generally bid lower for unicorn-containing funds, Bender explained.

Despite a second annual drop in deal volume, 2016 was the third biggest year of secondaries trading ever, and the firm predicts deal volume will hit a record high in 2017 due to strong pricing and a record amount of dry powder chasing lower dealflow.

“One of the drivers of the volume decline in 2016 was the drop-off in the number $1 billion plus transactions, which have historically been sporadic and difficult to predict,” Bender said. “To that end, we don’t see any kind of broader structural shift in the market or buyer-seller behaviours. Based on these considerations, we believe the market will revert back to its long-term upward trajectory in 2017.”

Below are four trends Greenhill Cogent expects will occur in 2017.

1. Pricing will remain at or slightly above current levels, driven by strong fundraising and pressure to deploy capital

2. The volume of pre-crisis funds will begin to decline, and we will see an increase in selling activity of 2010 and newer funds

3. Real estate and energy volume will rebound and contribute over 15 percent of total market volume

4. GP-led transactions will expand with a higher proportion of deals being completed in 2017 versus 2016