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Secondary pricing is decoupling from NAVs

With a time-lag on public market volatility, a fund’s NAV may not portray the fair value of secondary assets in the current market, so valuation methods are evolving in other ways…

With a time-lag on public market volatility, a fund’s NAV may not portray the fair value of secondary assets in the current market, so valuation methods are evolving in other ways…

The private equity secondary market known today was born in a world of discounts, driven by unloved assets largely unable to find a home through more traditional exit routes. 

In recent years, premium pricing has become more common as trophy assets have been re-housed in continuation vehicles. 

“We had one buyer last year tell us that they weren’t participating [in a GP-led transaction] because the price was too good, this is a real consideration,” says Sunaina Sinha Haldea at Raymond James. 

Private equity secondaries have traditionally priced between a discount or a premium to net asset value (NAV) within an average range of 90 to 105, where 100 is par. 

Given that NAVs are typically updated quarterly, this method of secondary pricing usually lags movements in the public market by a number of months. 

In the current market this means portfolios pegged to valuations from September 30 would not have taken account of the tech sell-off in January or the war in Ukraine. End of December values, usually set in April, may be equally unhelpful for guidance on the fair value of secondary assets, say sources. 

“It’s hard to have strong conviction when there is so much volatility,” says Nigel Dawn, senior managing director and head of Evercore’s Private Capital Advisory Group. 

Valuation concern

Average secondary pricing as of the fourth quarter 2021 came in around 97% of NAV, according to Jefferies’ full-year volume report for the market. 

Looking ahead at 2022, only one in five respondents to a survey by Private Equity Wire in March believe that the pricing of secondary assets coming to market would see a premium to NAV. The vast majority expected pricing to below par or at par. Around 70% said they would have concerns about valuation of these assets in the current market. 

According to Setter Capital, average NAV valuations will increase 3.4% in FY 2022. This is less optimistic than in 2020, when buyers expected NAVs to increase by 5.1% in 2021. 

For secondary investors attempting to read through the uncertainty caused by Russia’s invasion of Ukraine, inflationary fears and resulting stock market volatility, there are two places to look for guidance. 

The first lies in two recent, but very different shocks: the Brexit vote in 2016; and the Covid-19 outbreak in Europe four years later. 

During the latter, the GP-led market paused globally for around four months while market participants went back to their drawing boards to figure out what would work. They adjusted quickly and landed on healthcare and technology as the most resilient sectors. 

The Russian invasion has not had the same impact on the GP-led market, but it still might. 

“My current view is that Brexit, the invasion, inflationary pressures will not shut down the GP-led market as Covid did but will rather lead to a rebalancing of the types of sponsors and companies that access this part of the secondary market,” says Jeff Hammer, global co-head of secondaries at Manulife. 

“The GP-led pipeline will likely see a different mix of opportunities – more US sponsors than European sponsors, more situations away the political risk of sanctions, more companies from ‘resurgent’ sectors such as defense, oil and gas. I believe we are seeing this shift already.” 

“There’s a certain degree of correlation between public and private market pricing,” says Valérie Handal at HarbourVest, “but so far market volatility has been inter-quarter so too early to tell what the effect on pricing will be. However, we haven’t seen that translate into a slowdown in activity in the market. We’re still having conversations with sellers, GPs, agents, and other players in the market, and deal flow remains strong.” 

Today’s value 

According to chief commercial officer at TitanBay Adam Harrison: “What we’re faced with now is a geopolitical crisis which will exhibit the same characteristics on valuations [as the pandemic] and create the same problems and uncertainties for material positions in portfolios.”

A second guide to GP-led pricing in 2022 can be found in how buyers are sidestepping a fund’s NAV to form their own valuation of underlying assets, supported by the increasing number of advisers entering the market and relationships secondary buyers have with sell-side GPs. 

“As the buyer universe evolves,” says Matthew Wesley at Jefferies, “buyers have really adjusted themselves to be more bottoms-up investors and they have found ways to get increasing conviction on assets independent of NAV. We have run processes where we haven’t even shown the book value to investors and got pricing purely independent of what book value is. I think it’s just more reflective of how this marketplace is becoming more like traditional M&A.” 

Such an approach can prove effective on single assets, particularly where a dual-track M&A process can prove fair value to existing LPs in the fund. 

“A lot of the pricing isn’t NAV focused at all, it’s really market-based,” says Immanuel Rubin, head of European secondaries at Campbell Lutyens. “The reality in GP-led [trades] is that you really have to evaluate the asset as it is today. Transactions often trade at significant premiums in line with what you would see if they were to do an M&A. If you think about the [secondary] market, it has to stack up with what the market would pay on a direct sale”. 

While an M&A valuation – looking at multiples of earnings, for example – may work for large single asset continuations, a multi-asset secondary trade may still look more to the underlying fund NAV. 

“I’ve been in this business a long time, and I think you’re never going to move fully away from the NAV – it’s the line in the sand, it’s where the discussion starts,” says Pilson at Triago. 

Line in the sand

According to another unnamed adviser: “I think [not using the NAV] is becoming more prevalent as the determination on a case-by-case basis that the NAV is not really representative of fair market value. It’s representative of some kind of value, but it’s not fair market. And in this particular circumstance, we identified early on that that NAV was not an appropriate indicator of value so we decided to use a valuation methodology as we would in the M&A market.” 

The move away from NAV-based pricing on single assets in the GP-led secondary market may also have another effect, though. 

“Most NAVs aren’t super aggressive,” says the unamed advisory source, “so in some ways, you’re negotiating against yourself or your clients.” 

As with private equity exit multiples in parts of the M&A market, it is very possible that pricing for secondary assets could follow a similar ascent, despite the current uncertainty.

Read the rest of the Private Equity Wire Insight Report: Holding On: How volatility will drive GP-led secondaries in 2022

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