“It will remain irrelevant.”
That was one secondaries market participant’s view of preferred equity, speaking at an industry conference earlier this year. Will the speaker be proved wrong? 17Capital’s Augustin Duhamel certainly believes so. We recently caught up with Duhamel, a managing partner and founder at the preferred equity specialist, to discuss the state and future of the strategy. You can listen to our podcast with him here.
Here are three takeaways from our conversation:
The market is bigger than it seems
Intermediaries’ reports that show the size of the preferred equity market is between $3 billion and $4 billion only paint one part of the picture – typically, secondaries buyers using preferred equity to finance deals or sellers who take on financing where a traditional secondaries sale option is more remote. But there’s an entire side market that is not captured in industry surveys, Duhamel says. He gives the example of a US manager that was looking for more capital to fund existing investments and follow-ons.
“They eventually decided to go for a preferred equity option, which allowed them to find the money they were looking for to invest into the portfolio, but at the same time was less dilutive for the equity they had raised already,” he says, adding his firm saw close to $10 billion in dealflow last year for such opportunities.
GP financing is gaining transaction
Specialist firms such as Dyal Capital Partners and Goldman Sachs’ Petershill unit have emerged to acquire minority stakes in GPs. There are some GPs that want cash but don’t like the idea of diluting their equity and have instead been taking on preferred equity as an alternative, Duhamel says, adding that his firm has closed several such deals.
A downturn could be a boon for the market
Market sources have previously told Secondaries Investor tales of deals done during the global financial crisis in which buyers acquired fund stakes at 100 percent discounts to net asset value as the seller simply wanted the unfunded obligation off its books. When the public market downturn hits, sellers in need of liquidity but who don’t want to sell at massive discounts could turn to preferred equity, Duhamel says.
“In today’s bull market we are offering more additional capital on the back of existing portfolios for people to keep investing or invest more,” he says. “When we see a turn of the cycle we will probably revert to more situations where preferred equity will be a good solution for people looking for liquidity.”