“Private Equity Secondary Market Outlook” by Sixpoint Partners’ Eric Zoller and Andrew Gulotta featured in Pensions & Investments
The piece can also be viewed on the Pensions & Investments Website: P&I
U.S. equity market volatility will trickle down to PE secondaries
Public markets are being barraged with plenty of macro uncertainty: depressed commodity prices, a stronger dollar, the Fed’s likelihood to raise interest rates and a global GDP slowdown, most significantly China’s slowing growth.
While it’s not clear if the second-longest bull market ever will come to an end, it is clear that we will continue to see volatility. The summer sell-off and recent market volatility was quite dramatic, particularly in Asia, but the bounce-back highlights the likelihood of future whipsaw movements in the market.
These recent market developments will shape, and to some extent have already shaped, the private equity secondary market through year-end and into 2016. Given the backdrop of historically strong secondary pricing for almost three years, there was already a growing sentiment that pricing would plateau. With quarter after quarter of write-ups and distributions, the fact that secondary buyers have continued to pay near par for U.S. and Western European buyout funds bodes well for sellers.
Secondary funds are under pressure to invest an estimated $50 billion of dry powder, according to Preqin. While Sixpoint expects pricing to remain competitive, we have already seen discounts widen in the short term as Q3 valuations were finalized and released.
The secondary market is a derivative of private equity generally, which is informed by public equity markets. The new uncertainty with China, and what that means for commodities and other export-dependent countries’ economies, will continue to have a ripple effect throughout equity markets, particularly U.S. equity markets. To what extent, no one knows, but the uncertainty itself has caused secondary buyers to hit a temporary “pause” button and, at a minimum, budget extra cushion in their underwriting cases. We expect pricing’s long ascent to par to end. The market expected a flattening, but sellers may now see a pullback. Some processes will get delayed, and others will may get pulled due to the proverbial bid-ask spread.
Whenever any market sees uncertainty ahead, flight to quality is an expected result. We expect higher-quality managers will continue to price strongly, but pricing will be more asset-specific and vintage-specific. In this new landscape, sellers will want to consider the following:
- Vintage — with three years of strong M&A markets driving purchase price multiples, older PE funds have divested most, if not all, of their more attractive, saleable companies — so what remains are companies that may be struggling or are still in transition. With this dynamic in play, we expect that fully committed, midlife funds (vintages 2009-2012) will garner the best pricing.
- Public exposure — many of the mature megabuyout funds (vintages 2005-2007) bear significant public equity exposure. Given market volatility, those funds will have challenged pricing.
- Adequate diversification — sellers are better off selling funds that have at least three portfolio companies remaining. Funds with one to two assets remaining can be grouped with several other tail-end funds to create a more diversified portfolio.
Eric Zoller is a co-founder and partner at Sixpoint. Andrew Gulotta is a director at Sixpoint.