NYPPEX: 2017 could be direct secondaries ‘bloodbath’

Average bids for so-called unicorns will fall by 10 percentage points following a year of 'unrealistic' valuations, according to a report by the advisory firm.

Sellers of direct secondaries assets can expect a “bloodbath” this year, with unicorn companies likely to attract bids at 10 percentage points less than in 2016 as previous valuations are shown to be unrealistic, according to NYPPEX Private Markets.

Direct secondaries dealflow will increase in 2017, while bids will hit 40 percent discounts to valuations of last capital rounds for many unicorns – private companies valued at $1 billion or more – the advisory firm wrote in its 2016 Secondary Private Equity Market Trends and 2017 Outlook.

“Many unicorns are overvalued which will increasingly be proven at exit,” Laurence Allen, NYPPEX’s chief executive, told Secondaries Investor.

The firm warns of steep declines to come in valuations and notes a significant market shift has already taken place. In 2016 tail-end funds – defined by NYPPEX as vehicles more than nine years old and/or funds with less than 30 percent of unrealised value versus contributed capital – comprised more than 50 percent of all LP stake transaction volume for the first time.

“Investors struggled to generate returns in 2016 as evidenced from reported returns of numerous pensions and endowments. As a result, investors wanted to hold their private equity assets, their highest returning asset historically and sell small balance tail-end funds which had nominal impact on returns,” Allen said.

The report, which will be sent to the advisory firm’s clients on 23 January, notes that sales of fund interests fell 7.1 percent to around $37.7 billion in 2016, down from $40.6 billion the previous year. NYPPEX includes hedge funds in addition to private equity, real estate and other alternatives asset classes in its methodology, Allen said.

While the firm says some unicorn company valuations will be shown to be unrealistic, it believes buyers will remain cautious until IPO and M&A volumes stabilise, IPO aftermarket prices steady, and returns at exit for later stage direct secondaries investors are greater than 1.1x.

The number of single interest deals increased in 2016 due to buyers seeking ways to deploy capital amid fewer sales of large portfolios, according to the report.

It also estimates LP stake deal volume will increase by at least 10 percent to a record $41.4 billion in 2017, as limited partners will be more encouraged to sell assets – particularly interests in non-core funds – due to lower distribution expectations.