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Leverage helps secondaries defy Q4 public slump

Deal volumes so far this year point to a bigger first quarter than last year, according to advisor Triago.

The secondaries market is defying the downturn in public markets, at least for the time being.

Secondaries deal volume stood at $6.3 billion in January, on track to exceed the $13 billion recorded during the first quarter of last year, according to a quarterly report by advisor and placement agent Triago.

This is despite the drop in the value of public stocks during the fourth quarter. In the past, declines in public markets have caused GPs to mark down the value of their portfolios, which in turn causes buyers to offer lower bids, resulting in sellers opting not to transact.

Global equities posted sharp declines last year due to concerns over a US-China trade war and slowing economic growth. The S&P 500 declined by 13.5 percent during the fourth quarter of last year.

Among the reasons for continued strong secondaries transaction volume are the still sanguine outlook for corporate earnings, sellers’ desire to dispose of stakes before a possible downturn and record leverage, Triago noted.

The proportion of secondaries deals by total transaction value that employed leverage in 2018 was 38 percent, compared with 23 percent in 2017. The amount of leverage used in a given deal averaged 52 percent, passing the halfway point for the first time. Buyers are continuing to make strong bids, keen to deploy capital and betting that their use of leverage will help produce the desired return.

“Leverage is smoothing the traditional cyclicality of secondary volume,” a Triago spokesman told Secondaries Investor.

Pinal Nicum, a partner in the secondaries team at Adams Street Partners, said buyers would need to remain diligent over the next two years.

“The last six or seven years, someone buying has known that the next quarter valuation is probably going to go up. That may not necessarily be the case over the next 12 or 24 months. That does mean you need higher conviction to be able to buy and pay the price.”

Triago noted that below average leverage on the underlying, generally mature, portfolio companies means that current levels of debt use are “within the bounds of what’s reasonable”.

Others believe that it could prove problematic in the event of a recession, particularly in relation to GP-led deals.

“We haven’t had a downturn since leverage started being used,” said a managing director from a mid-sized buyer. “I think on the GP-led side, if you haven’t fully diligenced those assets, you could find yourself having a nasty surprise.”