Discounting the discount

Good deals at a discount have been becoming harder to find in Europe for a while now, so what are GPs doing if they’re not playing the discount game?

This week we wrote about BNP Paribas’ sale of stakes in Europe-focused real estate funds, which it said it had sold at a mere 1 percent discount to net asset value (NAV).

While it may seem a tiny discount to NAV, that’s not so unusual in today’s market. In fact, one source who brokers real estate secondaries in Europe told me he hadn’t seen a transaction close at a big discount in the past year.

Large discounts on good quality funds have become more difficult to find for a couple of reasons. One, there’s more competition, even for small LP stakes – with buyers of all sizes swooping in opportunistically. And two, high valuations on the primary side mean deals – particularly for direct secondaries – are harder to close because buyers believe assets may be overpriced.

Pricing for secondaries fund stakes remains at historically high levels, with an average high bid of 92 percent of NAV in the first half of 2015, according to a report by Greenhill Cogent.

Secondaries buyers like purchasing assets at a discount because it allows them to book an immediate gain on paper, but that’s not a viable strategy in today’s environment.

As a result, some buyers are holding off on deals until the bid-ask spread narrows if they can’t find attractive deals that fit with their investment mandate. Secondaries had 42.6 percent of committed capital remaining uncalled, the highest out of all private equity fund strategies, according to a report last year by TorreyCove Capital Partners.

But there are still active buyers purchasing assets with the expectation that they’ll capture upside and/or build strategic relationships with quality fund managers. And there are a number considering a push into uncharted territories like Ukraine and Russia, where up to 70 percent discounts can still be found. “The higher the political or macro risks, the higher the potential discounts, and in Europe that’s currently far eastern Europe,” a partner at a European fund of funds told me.

Each of these strategies comes with its own set of problems, of course. Holding off on deals can make LPs in secondaries funds question GPs’ abilities, and this may make them think twice about committing to subsequent funds. Paying high prices can be good if the upside pays off, but there’s the risk the value of the assets won’t increase past their already high valuations. And pushing into emerging markets comes with certain political or macro risks.

Pricing doesn’t look like it will drop any time soon according to a survey by Evercore released this week, with almost two-thirds of respondents saying they believe pricing levels will remain generally the same, and around 10 percent saying pricing will increase. Whether this will happen is debatable, with volatility in public markets likely to affect NAVs.

But in the end, it’s the quality of the assets, not the price, that’s important to secondaries buyers. The trouble is finding attractive levels of both.

Are discounts so important? Tell me your thoughts at adam.l@peimedia.com