The secondaries market’s black swan

The economic shock caused by coronavirus is already filtering down into the asset class.

For a decade, investment professionals have been wondering when the market cycle would finally turn and for what reason. The covid-19 pandemic could be that reason. The immediate effect of the virus on the secondaries market has been marked; its medium-to-long-term impact, difficult to gauge. Here are some early observations.

No more walking the factory floor

Travel bans are making company-level due diligence almost impossible, leading to increasing numbers of stalled GP-led processes, particularly single-asset deals, Secondaries Investor understands after having spoken with around a dozen market sources this week. We have heard of at least four GP-led deals that are struggling to progress amid the crisis.

A big advantage of portfolio trades is the reduced importance of face time. Diligence to a certain extent can, of course, be done from the safety of one’s desktop, and at least one participant expressed the hope that a successful period of enforced video conferencing might, in the long run, lead to a reduction in unnecessary travel.

But getting a deal over the line might still prove difficult.

“You can price a portfolio from your couch with a laptop and a phone, but no one will sign a $300 million deal over Skype,” said one New York-headquartered advisor.

Valuations in the air

The difficulty in getting deals done is compounded by the fact that GPs are still working out how the decline in public markets caused by covid-19 and Monday’s drop in oil prices will impact December and March valuations. There will be write-downs, but by how much and in which assets?

“Any business that has some kind of supply chain or has short-term liquidity requirements is going to suffer,” says one non-traditional buyer based in London. “There is potential [growth] for businesses that encourage you to stay at home: Netflix, teleconferencing software … For good companies this is a short-term hit and could prove a great buying opportunity,” he added.

That positivity was shared by lawyers from Paul, Weiss, Rifkind, Wharton & Garrison this week, who noted that delayed exits could lead to an eventual uptick in GP-led activity.

Sellers holding back

Sellside sources say that while high-quality portfolios are still changing hands, pricing expectations are beginning to diverge. Anticipating a big reduction in March NAVs, a number of opportunistic sellers have also paused transactions. According to Michael Granoff, Pomona Capital’s chief executive, they are likely to be replaced by “motivated sellers” driven to market by a need for liquidity or over-exposure to private equity.

“That will probably be a good opportunity for us, but I don’t think that rotation will happen in an even way,” he says. “We may see the exit of the first group before the entry of more motivated sellers.”

Negotiate, renegotiate

There has been an increase in buyers looking to renegotiate deals and take a second stab at underwriting in light of declining public-market comparables: “Some of our counterparties are saying ‘you have to close, we agreed to it’,” says one Asia-based buyside source. “We’re saying ‘circumstances have changed’ … We think there may be delays in some business plans of two-to-four quarters.”

Volatile conditions can create a potential goldmine for savvy secondaries buyers – as anyone old enough to have experienced the 2008 financial crisis will know. Of course, that crisis wasn’t accompanied by a global health pandemic. In the words of one veteran sellside source: “I can’t remember a time when entire countries have just shut down, when schools have shut down, when you weren’t allowed to shake people’s hands. It’s unprecedented.”

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