Closing Secondaries in The Current Environment
David Swanson, Unigestion Private Equity, discusses capital deployment amid the recovery in the secondary market
- The secondaries market has opened up again, particularly in the GP-led space. Unigestion’s latest secondary programme is on track to close seven secondary deals in 2020.
- The recovery in LP stake sales has lagged on valuation concerns while demand for higher quality deals has supported high pricing relative to NAV.
- GPs are looking for alternative liquidity solutions in light of delayed exits and lower DPIs. Therefore, GP-led transaction volumes are likely to increase into 2021.
Since the onset of the Covid-19 crisis, the secondaries market has recovered in the GP-led space faster than in the LP stakes space, according to David Swanson, Principle, Unigestion Private Equity. “If you had asked me in July how the year would progress, I would have said it would be a down year with the pandemic and lack of deal volume, but now 2020 might even be a record year of deployment for us, since the market has opened up again, particularly in the GP-led space.”
What is driving the recovery of the secondaries market, what opportunities exist in GP-led transactions and how has Unigestion been able to close deals in this challenging environment?
LP stake sales vs GP-led transactions
LP stake sales have taken longer to recover following June valuations and the recovery of the public market, since sellers are exercising caution. “As a seller, it has made sense to wait on the sidelines for private market valuations to follow,” says Swanson. “Secondary funds that focus solely on LP stakes have had a deployment pause, but volumes will come back up; LP stakes made up around 60-70% of the market in 2019 and we are likely to return to those levels if there is no significant worsening of the pandemic.”
Swanson says there has continued to be less distress than was initially anticipated. Nevertheless, that distress could still materialise, given the uncertain direction of the pandemic: “No seller wants to be distressed and sell assets at a big discount, and they will exhaust all other alternatives first. But we still could see distress – the pandemic is getting worse in some areas and there is a lot of uncertainty as to its continued impact.”
Pricing has remained punchy following Q1 and Q2 disparities. “There has been a flight to quality, particularly where company business models and their resilience can truly be understood,” says Swanson, reflecting the bifurcation seen in the current buyout market. “For quality positions there is not much of a discount to net asset values. However, holding periods have been pushed out, and that has led investors to underwrite greater time until exit.”
A growing opportunity in GP-led deals
The trend towards longer holding periods in a challenging exit environment is likely to affect the market significantly going forward, presenting new opportunities for secondaries and differentiated liquidity solutions. “We are in an environment where there has not been significant DPI generation for GPs,” says Swanson. “Portfolio companies that were meant to hit certain performance targets in 2020 are now expected to hit those targets in 2021 or beyond. This has delayed exits and therefore brought GPs to the secondary market for a solution. A GP-led deal can solve the tension between the desire to generate liquidity and the GP’s desire to not sell assets at a sub-optimal time.”
For quality positions there is not much of a discount to net asset values. However, holding periods have been pushed out, and that has led investors to underwrite greater time until exit.
Swanson predicts a high volume of GP-led secondaries deals in Q4 2020 and in 2021, accompanied by a rebound of the LP stakes market. “LPs will, at some point, need to rebalance, trim old positions, etc. Once there is more clarity around net asset values in Q3 and Q4, you could see sellers of LP interests return to market and transact off those reference dates. However, the pandemic, the uncertainty following the US election, Brexit and other geopolitical events could lead to a lot of volatility, which will affect how buyers and sellers approach the market.”
The pandemic, the uncertainty following the US election, Brexit and other geopolitical events could lead to volatility, which will affect how buyers and sellers approach the market.
Closing deals in a crisis
Of Unigestion’s own strategy, Swanson says: “Deployment is going well so far for our latest programme; we will have done seven deals by the end of the year, having made the first one in September.” Unigestion is on the road for its fifth secondaries strategy, which has a target of EUR 700m. The strategy focuses on small-cap, non-auctioned, GP-led deals valued at less than EUR 50m, although it could opportunistically target LP stakes.
Deployment is going well so far; we will have done seven deals by the end of the year, having made the first one in September.
The development of digital due diligence and the adaptation to home working has been key in keeping up deployment, Swanson says. “In all our deals, we want to meet management teams of the underlying companies, and continue to do deep due diligence, and we have still been able to do that. I think the global response to accommodate working from home has been very impressive. The technology and the resources that have come into play have really enabled a thorough diligence process.”
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Document issued November 2020.