Secondary assets being brought to market this year will require industrial strength and value creation potential, as infrastructure, VC and mid-market GPs plan to bring opportunities to market…
In stark contrast to private equity’s buyout market over the past decade, GP-led secondaries are often characterised by too many deals chasing too little capital.
“Sometimes we feel capital-constrained because there’s so much opportunity out there,” says Valérie Handal, managing director of the global secondaries team at HarbourVest.
With the eight largest secondary funds controlling around 50% of the dry powder in the market, according to Hamilton Lane, GPs are having to carefully consider what assets to bring to these buyers and in what form.
Last year, multi-asset continuations represented 42% of deal volume, according to investment bank Greenhill, but it also noted an increase in more concentrated multi-assets CVs (holding only two or three assets) along with a rise in the proportion of single-asset transactions, from 31% of the market in 2020 to 39% of GP-led volume.
Many of the single-asset continuations completed in 2021 were primarily in high-quality, COVID-resilient and growth sectors, it found.
Though the pandemic-spurred liquidity raises of 2020 now appear to be fading, strategic drivers, familiarity with the concept and macro uncertainty will increase the attractiveness of using continuation vehicles as safe harbour and surgical portfolio management, say sources.
In a survey carried out by Private Equity Wire in March, 96% of respondents said they considered continuation vehicles to be viable alternative to the sale/exit of an asset(s) in the current market and 80% said they would use the structure for both single assets and multiple assets.
It is less clear how their attitudes have changed to particular sectors and which assets will be favoured by secondary buyers in a more volatile market: when asked ‘what types of assets do you see coming to the secondary market in 2022?’, the same survey respondents cited everything from energy to healthcare to technology.
In reality, for single-asset continuations at least, some processes that have already begun may now face delays or repricing at a different level than they would have achieved last year. But others, even in technology, are showing little correlation with shock movements in the public market.
“We’ve approached Q1 with a lot of caution,” says Hani El Khoury at Coller Capital, “and I think we will continue to do that. Now is the time to be very cautious on valuations across sectors. In terms of what we are looking at, I would focus more on profitable growth rather than growth at all costs.”
“[The volatility] is making people pull back, go a little slower, be a little bit more methodical, and that’s going to have an effect on valuations across the board,” says Michael Pilson at Triago, adding that a recent tech sell-off in the public markets has given secondary buyers pause but these assets are expected to return once volatility lessens.
Demand in some sectors is more robust. “There’s just a ton of demand for healthcare,” says Pilson. “I think secondary buyers are very much looking for exposures to the themes that have been driving primary fundraises, where they might have missed out.”
GP-led activity will be more subdued on technology assets this year, says Nigel Dawn, senior managing director and head of Evercore’s Private Capital Advisory Group, with more demand evident for “cash flowing industrial businesses, perhaps consumer or retail could be more attractive in this environment”.
Covid-recovery play
“We have seen something of a ‘Covid-recovery’ play in recent months,” says Jeff Hammer, global co-head of secondaries at Manulife Investment Management. “Sectors out of favour these past two years – think restaurants, fitness, retailers, leisure – have shown up in recent GP-Led transactions either demonstrating their financial resilience or seeking forgiveness for pandemic-induced distortions to their finances.”
One adviser cites an unnamed secondary process coming to market in 2022 involving two US restaurant businesses that will command high demand but is quick to clarify that what GPs currently deem suitable for continuation is not necessarily tied to sector.
“Trophy assets are ‘industrial strength’ businesses of enduring substance,” says Hammer. “They have proven management teams, diverse customer bases, multiple suppliers, and mature financials.”
The assets that are being identified for continuation, and potentially coming into the secondary market in 2022 and 2023, must therefore have the potential for further growth organically and through M&A.
This is demonstrated by GPs agreeing to re-invest 100% of carry proceeds into continuation vehicle transactions alongside secondary buyers, resulting in strong alignment and suggesting that GPs believe in the go-forward return potential of these investments, says consultant Hamilton Lane.
In some cases, GPs are going out of pocket to invest additional capital into the transaction, literally buying into the ‘support the winners’ thesis themselves, it adds.
Infrastructure and venture capital funds are also increasingly looking at the space in 2022. Some of the largest continuations in recent years have been infrastructure assets, such as Global Infrastructure Partners’ 2019 Gatwick Airport secondary sale. During the end of last year, Stonepeak raised around USD 3bn for a single-asset continuation of North American data centre platform Cologix, which it acquired in 2017 through a 2015 vintage infrastructure fund.
Stafford Capital Partners has been an early investor in infrastructure secondaries, since 2012, and is nearing final close on a fourth fund with this strategy.
Venture capital GPs are also seeing the appeal of continuation vehicles. At the end of last year, StepStone Group held an interim close on the largest reported venture capital secondaries fund, raising over USD 2bn.
In February German VC firm HV Capital launched a continuation fund of EUR 430m, with HarbourVest and LGT Capital Partners investing among others, to house all its existing investments from 2010-15. Speaking of the move, HV general partner David Kuczek was quoted as saying: “I haven’t sold many companies before because I believe the real value creation happens after many years.”
Getting burned
Scratching the traditional route for many tech-based VC firms – an IPO – he went on to say: “Startups are getting burned by public markets. Look at Peloton, look at Delivery Hero. If you make one mistake, or don’t meet expectations, you have follow-on problems,” adding that public markets “aren’t for everyone”.
Approximately 70% of transaction volume in the GP-led market last year involved companies that were six years or younger, with almost one-third of that involving companies that were three years or younger, according to Campbell Lutyens’ Secondary Market Overview 2022.
The strongest interest is for younger funds of well-known top quartile large cap GPs coming out of their investment period, says Greenhill, as well as late-stage venture and growth funds but it also observed select appetite for tail-end funds with near-term liquidity prospects.
Neither trend is surprising, but with an increase in continuations more generally, particularly from mid-market and lower mid-market GPs testing the structure, some secondary funds and buyers may start to play the market differently.
“It’s easier to underwrite a business that’s performed very well in the past and extrapolate that it will continue to perform well in the future – hence the term ‘continuation fund’,” says Matthew Wesley, global head of GP advisory and global co-head of private capital advisory at Jefferies.
“I think what will emerge in the future is a set of buyers who are not turnaround investors, per se, but investors who are able to dig a couple layers deeper and understand what a turnaround story could look like.”
“Secondary assets could be marketed more as value creation opportunities – not just purely trophy assets, but solid businesses that need two or three more years for true value creation.”
The secondary buyer universe will start to increasingly specialize over the next five years, he says: “there will be a stratification”, rather than “everyone chasing the high-flying assets”.
Regional story
One example of this, offered by Larry Abraham-Ajayi, vp at Setter Capital, is Swiss-based Mill Reef, established in 2019, which focuses on GP-led secondary opportunities in technology and healthcare.
Among the supply of GP-led opportunities, there is also a regional growth story to observe.
North America dominates GP-led activity: sellers there continued to account for the largest proportion of deal volume last year, according to Greenhill, selling USD 103.63bn, with Western European sellers representing USD 30.97bn and Asia Pacific sellers accounting for about USD 8.21bn.
The figures offer a clue on where growth in GP-led activity could evolve next.
Greenhill expects pan-Asian GPs and specifically GPs in Korea, Japan and Australia to emulate their North American and European peers to embrace the use of secondary market tools.
“We also continue to be excited by opportunities in the venture and growth space in Southeast Asia and India, with a focus on technology and the rising consumer class,” it says.
Read the rest of the Private Equity Wire Insight Report: Holding On: How volatility will drive GP-led secondaries in 2022
