AlpInvest’s Neal Costello on the continued rise of single-asset secondary deals
In a yet a further sign of continuing maturity in private equity, its secondary market is being driven by GP-led deals, giving rise to a greater proliferation of single asset transactions. And as AlpInvest’s Neal Costello explains, this is presenting wider opportunities for liquidity providers.
Single asset transactions are becoming a staple of the private equity secondaries marketplace, further illustrating how the depth and diversity of liquidity continues to evolve.
The primary driver for these GP-led deals is to transfer assets that have yet to be fully realized (in terms of value) from a fund coming to the end of maturity, into a continuation vehicle. And whereas four or five years ago, such deals typically involved a handful of assets, they now increasingly consist of two or three assets – and even one asset in certain cases – marking a clear shift in deal profile.
“We are seeing these transactions across the globe being used for liquidity for existing LPs,” comments Neal Costello, Partner in the Secondary Investments team at AlpInvest.
“We didn’t see the single asset phenomenon two or three years’ ago. It was more of a faux pas if a manager was seen to be doing that. Now, LPs are not putting up a fight, though they will ask a lot of questions to understand why the GP wants to do it as opposed to just selling the asset.
“If the alignment of interests is there, and the GP is rolling over capital or putting in new capital, and showing that like-mindedness to someone like us, then it can absolutely work.”
As InfrastructureInvestor reported last August, citing a report by Evercore, single-asset secondary deals accounted for almost one third of GP-led deals through the first half of 2020. And whilst Costello explains that he doesn’t have exact up-to-the-minute statistics for 2021, he does confirm that AlpInvest is seeing one of these deals seemingly on a weekly basis.
Quite often, the GP will feel there is still room for value creation, perhaps through improved capital expenditure, continued M&A… anything that could take the company to a higher valuation level. In setting up a continuation vehicle, some LPs in the existing fund will want the flexibility to exit and be offered liquidity at a fair price. This is where buyers like AlpInvest come in, pricing that liquidity and giving both managers and investors a liquidity solution.
“This allows the GP to hold the asset at a market-cleared price,” adds Costello.
For buyers of secondary interests it all starts with the quality of the GP. This is even more germane when considering single-asset transactions where the risk exposure is demonstrably higher than a diversified portfolio of LP interests, for example.
Investors like AlpInvest will typically focus on purchasing the right mix of LP-led interests and GP-led interests and in relation to the latter, Costello is keen to emphasise: “Whenever doing one of these deals we have to think about three things: GP quality, assets that still have value creation potential, and perhaps most importantly, proper alignment and incentive structures in place to be able to do them effectively.
“We’re not looking to invest in situations where the GP is simply kicking the can down the road. It’s more about, ‘How do we work together with the GP to find an optimal solution to capture value creation?’”
To underscore how important the PE secondaries space has become, one need only refer to the size of new funds coming to market. AlpInvest’s latest fund – known as AlpInvest Secondaries Program VII (“ASP VII”) – raised USD9 billion in closed and reserved commitments, in addition to closing on an additional USD1.2 billion in committed co-investment vehicles; this exceeded the firm’s original USD8 billion target.
Looking at the optics of secondary deal flow, Costello says there has been a strong rebound in 2021, following last year’s dip in respect to both asset volume and asset quality.
“At the outset of the pandemic, there was significant activity in LP interest trades but then valuations went up drastically, which made it difficult to get buyers and sellers on the same page. As a result, we saw lower overall volume in 2020,” states Costello.
That much of the activity in secondary markets over the last 12 months has been GP-led is largely a function of public market performance. As anyone reading this will know, since the second half of 2020 US equities have enjoyed a surge in growth, propelled in part by the Biden election victory last November. Vaccine developments have also played a key role in supporting market confidence.
The upshot to this is that an LP holding PE fund interests has enjoyed a purple patch of performance, as corporate valuations have continued to rise in some – not all – areas of the economy, making them less inclined to sell.
In Costello’s view, LP interest deals might start to increase if there is a bump in public market performance, as was witnessed last March/April “and which highlighted to us how much the LP interest market ebbs and flows”.
Not that one should regard valuations as the singular consideration for LP deals.
“What we often see,” says Costello, “is the LP needing to rebalance their portfolio, or reallocate money to different managers in part of their portfolio. That’s where I think there will always be continuous volume. That base is always there but if markets become more volatile it could also lead to more activity on the LP side.”
While the arena for PE secondary investors remains competitive, the key is to be patient. “We don’t invest our fund in one year, we invest it across a number of years,” asserts Costello. “We try to keep those guardrails in mind as we’re looking for new deals and constructing the portfolio. You have to be prepared for ups and downs.”
What is also necessary is for investors to look at assets through a common lens, regardless of whether these are portfolios of LP interests, or GP-led single asset transactions. This is especially important in today’s marketplace, where investors need to be comfortable paying the right price to step in to secondary investments.
One can never be certain by how much a particular asset class, let alone secondaries, might grow in any given year but after the hiatus seen in 2020, it is likely that overall deal volume will be noticeably stronger in 2021.
“It’s not only that the market volume is increasing… the type of deals is also growing dramatically. We don’t have a specific number in mind; some think secondary deal flow will exceed USD100 billion, but it’s too soon in the year to quantify it.
“If the early trend we’ve seen continues, it could be a record year,” concludes Costello.