www.realdeals.eu.com REALDEALS 13

Against all expectations, 2009 was another quiet year for the secondaries industry. Five of the market’s most respected players discuss what went wrong and why 2010 will prove different.

For the past two years, the secondaries industry

has been adamant that its big moment is just

around the corner. Indeed, at this very table

a year ago, everyone was convinced we were

on the cusp of an explosion in activity. But

despite this confidence, 2009, in fact, produced

very few sizeable secondaries transactions. Is

that mountain of deal flow finally converting

into completed deals, or is there now an

acceptance that the market misjudged the

scale of the opportunity?

Groen: What we all forgot was that when prices

fall off a cliff, nobody will sell unless they are

desperate. Yes there was a lot of deal flow, but

at the end of the day people won’t sell at 70, 80,

90 or even 100 per cent discounts, unless they

are absolutely forced to. That was the problem.

At those prices there was no way we could get

chAired by amy carroll PhotogrAPhy rIchard Gleed

every second counts

at the table (clockwise, from left) nigel van Zyl sJ BerwinVan Zyl is a partner in SJ Berwin’s private

funds group, as well as advising on secondary

transactions. He joined the firm in 2007.

Marleen Groen Greenpark capitalGroen is principal founder and chief executive

of Greenpark, and has more than 14 years of

global secondaries experience.

oliver Gardey Pomona capitalGardey joined Pomona in 2009 and heads

the firm’s European operations. He has 15

years of private equity experience.

Julian Mash Vision capitalMash founded Vision Capital in 1997 and is

the firm’s chief executive. He has previously

served at H&M Partners and Smith Barney.

david atterbury HarbourVest PartnersAtterbury is principal at Harbourvest, having

joined the firm in 2004. He has led a range

of European secondary transactions.

Sponsored by secondaries

www.realdeals.eu.com REALDEALS 15

secondaries

anywhere near the $130bn (¤92bn) tsunami of

secondaries deals that was being talked about.

and now? What is a realistic estimate of the

size of this potential market?

Groen: I still don’t think its $130bn. But it could

quite easily go back to the $20bn that it was

in 2008. There is a lot of pent-up demand.

Gardey: There are a couple of drivers now that

mean we are going to see the market pick up.

First, there is a lot more visibility on performance,

and a lot more certainty, which means buyers’

appetites have increased and pricing has got

tighter. Equally, on the supply side, sellers can

now afford to sell. If you were a bank being

offered a 50 per cent discount in 2009, you

couldn’t afford to sell because there is a direct

impact on the balance sheet and capital tier-one

ratio. Now, however, the banks have been bailed

out, their balance sheets are stronger and they

are profitable again, so they can afford to sell.

And, of course, the discounts being offered are

lower anyway.

What we have seen in the past two months

is that these supply and demand-side drivers

are coming together and some very large deals

are starting to get done. It is a very

different market from last year.

atterbury: To echo Marleen’s

point, I think pricing got to

such a low point last year

that it wasn’t surprising

that people didn’t

transact. Then, as

Oliver said, as stability

started to return in

the second half of

the year, vendors started to come back to the

market. But inevitably there’s a lead time. It takes

two or three months for those deals to get up

and running, and then another two or three

months to actually get into a process. So we

are now starting to see the conversion of some

of those opportunities in the first half of 2010.

The Bank of America deal, for example, has

been talked about for a long time. The banks

were very patient last year and nobody sold at

the huge discounts we had hoped for. But they

have now reached a point where they

feel there is enough stability for

transactions to take place.

We have seen a couple

of big deals already, and

our expectation is that

there will be more

throughout the year.

$130bn? Probably

not, but a significant

volume of trade.

are the banks also proving a significant source

of deal flow on the direct secondaries side?

Mash: The banks are a major source of

conversations, but not yet a major source of

deal flow. To my mind, though, while I accept the

points being made about the banks stabilising

their balance sheets, the critical driver of why

this flood never happened is actually just interest

rates. The cost of holding an asset that you

strategically do not want to own is low if interest

rates are low, so the penalty for doing nothing is

low, and that will probably remain the case for

quite some time.

So I believe that the transactions that do

get done will be driven by a strategic shift of

some description – rather than prices going

up and down – deals where there is a higher-

level objective, and that’s what we look for.

Our investments at the moment are all about

re-energising companies that have been in limbo

through what we all hope is the bottom of the

cycle, and that are now ready to grow once again.

atterbury: I hear Julian’s point, but I think banks

are in a slightly different position because of the

regulatory pressures they face, which means they

are now prepared to take some level of discount

to achieve their strategic objectives.

as direct investment picks up, and as call downs

proliferate, do you expect to see a second wave

of distressed transactions?

atterbury: In actual fact, we have seen an

increasing level of distribution activity through

the first five months of this year. In our portfolio,

we have probably seen more distributions than

capital calls. Last year we talked a lot about

the pressure on sellers that would result from

increased capital call pace, but that hasn’t really

materialised. It seems firms are selling more

than they are buying, so that pressure hasn’t

really come to bite.

Gardey: The pressures to sell will come from

regulatory and strategic changes rather than

distress. There will be isolated cases involving

family offices and local banks, for example,

that didn’t clean up enough last year. There may

also be some local dynamics, if the situation in

Greece contaminates more of Europe.

But in general, most of the deal flow will be

driven by regulation pressures and portfolio

restructuring. Governments, and the European

Council, are busy talking about what to do about

Basle II framework, increasing capital tier-one

ratios and how to avoid “too big to fail” scenarios

within the financial services industry.

There is also a very strong trend to disallow

or penalise proprietary trading transactions

and ownership of private equity interests on

balance sheets. In addition, insurance companies

are going through a major review regarding

Solvency II. If you talk to a lot of insurance

companies in Europe, most are sitting on their

hands because they don’t want to do anything

in private equity until Solvency II regulation

has been clarified. On top of those regulatory

factors there have been strategic shifts, where

“the amount of money going into private equity as a whole is down, but the secondaries component within that is bigger”

16 REALDEALS 20 May 2010

banks are realising that “pay to play” – investing

in private equity funds in order to get business

from those funds – is not as strategically

important to them as it used to be.

Groen: I would also say that the general portfolio

management that was driving sales in 2005 and

2006 has returned. Ultimately, a lot of secondary

funds have been raised. There is a lot of unspent

capital. Pricing is quite attractive again, discounts

are lower against lower valuations, and there is

a lot more certainty. It is a good time to sell.

Where do discounts currently stand?

Groen: The whole concept of discounts is a red

herring. Valuations at a conservative level would

make a deal at a very small discount potentially

extremely attractive. Equally, aggressive valuations

could make a big discount deal not very

attractive. And that has always been the case.

Mash: I couldn’t agree more with that. In a lot of

our deals there is no NAV. We don’t even know

what the discount might be. We’ve just paid

Palamon 3.7 times their money for Nordax Finans

at a premium to NAV. They are happy and so are

we. Whatever the theoretical discount may be is

completely meaningless, because we are looking

at the future prospects of the business and not

their historical bookkeeping.

atterbury: It may be more appropriate to flip the

concept around, and look at what are our return

expectations on a deal are. I would say that the

market moved to a risk premium to the long-

term average through the first half of last year,

and I think that’s come back down across the

industry. So pricing is probably more consistent

– in terms of our target expectations – with

2007 and 2008 than with the past 18 months.

van Zyl: But for a financial institution seller

going to their board, pricing to current NAV is

helpful because of their accountability to public

shareholders and so on. It is far easier to get a

deal through board approval when the price

offered is nearer to NAV.

Mash: Of course, who wants to take a loss on

a transaction?

Groen: Certainly, a lot of the deals that are

happening this year are the deals that were

all lined up last year, but just didn’t happen

because sellers couldn’t stomach the discount.

Interestingly though, it could well be that a

number of the deals that go through in 2010

will be priced lower, in real terms, than was

offered for the same assets in 2009.

What about the dynamics of the sales process?

over the past 18 months, pricing has been such

that intermediaries have been touting shopping

lists of fund interests to scores of potential

buyers, allowing them to pick off assets one

by one in order to generate the best deal for

the seller. Is that still the case?

van Zyl: Most of the larger transactions that have

taken place this year have been intermediated.

atterbury: But no, those portfolios haven’t been

broken up. With pricing moving up, there is less

of a need to split portfolios up into a thousand

pieces, because buyers are willing to take a little

bit of the good and the bad together in terms

of providing a solution. It is far easier to sell

20 fund interests to one buyer than two fund

interests to ten buyers.

In fact, there aren’t a lot of intermediated

processes on the go at the moment that I am

aware of. Most of our discussions are happening

on a more direct basis. But that said, I am

quite sure we are probably having the same

conversations that other people are having

with the same seller.

The two big deals that have taken place

this year involved that kind of dynamic. Lots

of potential buyers were speaking to those

sellers on a direct basis and the intermediaries

were bypassed.

Gardey: I would slightly disagree, or rather put

another nuance on it. I think deal flow has been

quite bifurcated. Some sellers have felt confident

to run a process on their own, but there are also

transactions where intermediaries are very much

at the forefront. The intermediaries are very busy

right now. These big portfolio sales are efficiently

processed and the pricing is quite high.

and are those types of sales still attracting

the non-traditional secondaries buyers that

dominated the acquisition of single interests,

which were going for a song last year?

Gardey: Yes, it is those large, heavily

intermediated deals where sovereign wealth

funds and big pension funds with large portfolios

feel that, with their access to the GP, they can

price things aggressively. That is why we are

spending a lot of time on sourcing and

origination, particularly looking for small

portfolios where the market is less efficient.

Groen: Certainly, some LPs have started to look

at doing secondaries deals themselves over the

past year or so, but interestingly, we are currently

talking with one investor who now says that their

secondaries activities are giving them – and I

quote – “absolute brain damage”, and they don’t

secondaries

www.realdeals.eu.com REALDEALS 17

want to continue. If you arm yourself with the

proper resources from the start, it may be

possible to come in as a non-specialist on the

more straightforward deals, but if you don’t, it

is very difficult indeed. New players have come

in, of course, and there will be more. But for

a lot of entrants that have been lured by huge

discounts in the last year or so, it just won’t work.

atterbury: It is far easier for a non-specialist to

come in when you have that mosaic effect in the

portfolio. If you have only got to buy four interests,

it is easier to find those interests

you know well and to price

them quickly and comfortably.

That was particularly true

when there was so much

unfunded available in

the marketplace. But if

you have to look at 20

fund interests that are

90 per cent funded

and you are only

invested in half of the names then it’s a lot

tougher. I think the market lent itself to the

sovereign wealth funds last year, but that is less

true now we have the bigger portfolios for sale.

Fund of funds that had not traditionally focused

on secondaries also stepped up their activities

last year. many of these fund of funds now

believe it is easier to raise secondaries money

than primary money, and so are either

increasing their secondaries allocations or

looking to raise dedicated capital.

But is it really still easier to raise

money in this part of the

asset class, or have lPs

lost enthusiasm as the

market has repeatedly

failed to take off?

Mash: You have to look

at the question in the

context of fundraising

as a whole. Yes, there

is a lot of support for secondaries. There is

also a lot of support for differentiation and

performance in general, regardless of the

strategy. But, if you look back to Oliver’s point

earlier, the banks and insurance companies are

disappearing as capital providers altogether.

Those institutions represented something in

the region of a third of all equity going into the

buyout world. The secondaries trades that are

coming to market are just a transition point in

this withdrawal. I don’t think anyone around this

table believes they are coming back any time

soon. These are far more important shifts than

the ebbs and flows of who is fundraising in

what year and with which proposition in mind.

Groen: But even though the amount of money

going into private equity as a whole may be

down, the secondaries component within that

has become much bigger. And it needs to.

Secondaries capital is only two or three per cent

of the primary market. That’s peanuts. All other

primary markets have much bigger secondary

markets than that.

Mash: Yes. The market we are talking about is

a fraction of the size that it rationally should be.

van Zyl: One of your competitors made a

comment the other day saying he thought there

was too much secondaries capital in Europe

chasing too few deals. What do you think?

Gardey: For the plain vanilla transactions

involving well-known buyer groups with well-

publicised information on the portfolio, the

market has become a lot more competitive.

That is a function of a lot of capital being

raised from non-traditional players, as well

as the fund of funds raising their own

secondaries funds, or increasing allocations.

However, those players are not set up to

deal with complex transactions where you

need to spend time understanding the leverage

situation, digging deep into the companies,

direct secondaries, or deals with structural issues.

That’s where our 15 years’ experience in the

secondaries market comes to play.

Groen: I would add that the European market is

really quite different from the US market, not

least because the average LP commitment is far

lower, which means transaction sizes fall below

the radar screens of most intermediaries, who

won’t get out of bed for anything less than

$100m. There are an awful lot of secondaries

transactions in the sub-$50m space.

atterbury: There has really been no change in

terms of the pricing of European deals and the

level of demand. The market for plain vanilla LP

interests has been highly competitive for the last

six or seven years – going back to the previous

boom and bust. On a relative basis, it has

consistently felt more competitive, pricing-wise,

for quality European names than for US names.

That is a function of the history of the market.

It is not as mature as the US.

Groen: There are also significant cultural and

linguistic differences between the two markets.

We are obviously a patchwork of cultures and

languages, and therefore it will be far more difficult

secondaries

“in the past two months, supply and demand-side drivers have come together and some large deals are getting done”

www.realdeals.eu.com REALDEALS 19

secondaries

– and I personally think impossible – for Europe

to ever become as efficient a market as the US.

Gardey: But the market is evolving nonetheless.

Julian was a pioneer of the whole direct

secondaries market in Europe, and we have seen

other niches where we, as a firm, are preparing

to set up dedicated funds and even dedicated

teams. For example, we see a great opportunity

in the secondaries co-investment space.

There has been a lot of co-investment done

over the past six or seven years, but traditionally,

secondaries players haven’t liked to buy single

assets. We see a real opportunity there.

Another area is energy. The energy market has

experienced great growth over the last five or six

years, but energy deals require a very different

mindset when it comes to due diligence and

understanding the teams. Very often, there is also

a strong regulatory component. We see a lot of

scope for increasing specialisation in secondaries.

last year, secondaries houses claimed that direct

secondaries deals were becoming, relatively

speaking, less attractive as the risk premium

on traditional lP secondaries increased.

have direct secondaries deals become more

attractive again, now that the pricing of lP

interest deals has become more competitive?

atterbury: It is true that last year we were hoping

there would still be opportunities to do fund

interest deals with our sense of the market risk

premium built in, and therefore to get those

deals done at very attractive discounts. If it

is possible to price an LP interest deal at the

same rate as a direct portfolio, then why take

the incremental risk? That didn’t necessarily

materialise, of course. The differential in returns

has gone back as the LP market has moved down

to more normalised long-term targeted returns.

That said, we have always been active in LP

interest and direct deals. We didn’t complete

on either in the first half of last year. Now we

are back closing on both.

how have the competitive dynamics of the

direct secondaries market evolved?

Mash: The market is becoming more competitive,

which is actually quite healthy. But what we really

compete against are alternative forms of sale. We

compete indirectly with the whole array of capital

and M&A markets. That is the most important form

of competition, because sellers are infrequently

distressed but often strategic. They do have

choices and we must provide better value.

and from the perspective of secondaries houses

that are providing the capital for these deals,

is the overall quality of “GP for hire” improving?

Groen: There are still very few GP-for-hire teams

that have built real track records. Many groups

never really get off the ground.

might we see direct investment GP teams that

are struggling to raise their own funds heading

down the GP-for-hire route?

Groen: A lot of GPs are trying to figure out how

to stay in business full stop. GPs don’t disappear.

Or if they do, they don’t disappear very

quickly. But at the same time, a lot of

GPs know that they will probably

not raise another fund, and

so they are trying to figure

out annex vehicles and

other structures to

enable them to keep

going. That is where

the more experienced

secondaries houses

can come in.

In these scenarios

– indeed in all

secondaries scenarios

in a market such as this,

where a large number of

GPs are unlikely to be able

to raise again – assessing the

quality of the GP franchise must

be more important than ever.

Groen: Absolutely. You need to figure out if

a GP with reducing management fees – as its

funds mature and without a new fund – is going

to milk the investee companies for additional

fees where he can, or if a GP is actually going

to do the right thing by his investors.

atterbury: The good thing is that we are

obviously 12 months on and there is more

visibility of performance of the underlying

operating companies. There is also more visibility

in terms of the team and future fundraising

prospects – where is the unfunded going to

go? Is it going to be used to support poorly

performing existing companies? Are they looking

for new deals? Is the investment period getting

close to terminating? And because there is more

visibility, you can price slightly more aggressively

around some realistic assumptions.

Gardey: I think it is also important to recognise

that the unfunded can actually be a great thing, if

you like the GP and if they have been disciplined.

Most deals done in 2006 and 2007 were done at

very high prices, and so the unfunded can give

you extra balance in a portfolio.

What about the acquisition of legacy portfolios

from GPs. 3i has obviously completed a number

of such deals, and Julian, you have also been

involved in similar transactions with a handful

of other buyout houses. But in general, do

private equity houses remain resistant to

the idea, or have unprecedented fundraising

pressures finally unblocked the dam?

Mash: We have lots of deals in our sights at the

moment involving buying what is left in fund one

and fund two, so that the GP can focus on fund

“new players have come in, and there will be more. But for a lot of those lured by discounts in the last year, it just won’t work”

20 REALDEALS 20 May 2010

three and raise fund four, for example. Those are

very good deals because companies in old funds

don’t have ready access to capital, which is

something we can provide them with.

And of course, these deals have a broader

relevance for fundraising. GPs may get stuck

for a long time, but ultimately, any private equity

houses that can’t raise new capital will go out

of business, however long it takes. Coming up

with creative structures that can help clarify a

firm’s future strategy or deal with succession,

anything that can enable a firm to move forward,

is incredibly valuable.

atterbury: Nevertheless, you need to be a pretty

enlightened GP to take that course of action.

We have been pushing this type of deal for some

time but if anything, GPs that are fearful of not

being able to fundraise cling even more tightly

on to their portfolios. It is often those portfolios

that are in need of a fresh team. I don’t think

this is ever going to be a huge market.

Mash: In reality, it tends to be the successful

and good-quality firms that are more willing

to innovate, and those are the teams we

are targeting in any case. If you are in that

dreadful rut of having no carry from your

current fund and being unlikely to ever raise

another, that creates all sorts of conflicts.

There are all kinds of unintended consequences

in the way that the economics of private equity

funds work. It all works fantastically well on

the upside, but there are a lot of conflicts on

the way down.

Groen: I would say though that GPs are more

reluctant to do these deals than their LPs are.

Ask any LP and they would love to get

liquidity from their older funds.

But ask any GP, and they’re

adamant that LPs would

object.

atterbury: What we are

seeing is some of our

GPs now actively

looking at their roster

of LPs and

approaching those

that they don’t think will be investing in their next

fund, then working with us to see if there is a way

we can approach those LPs. In other words, they

are proactively managing their LP base in

advance of a future fundraising.

Gardey: Certainly, GPs have become much more

focused on LP relationships. They are hiring

internal IR functions if they didn’t previously

have them, and they are focusing more on LP

communication, which means they understand

far better who is a potential seller. At some of

the bigger firms, when a secondaries transaction

comes up, an internal online marketplace will

be set up to match sellers with buyers. That is

an indication of how much more sophisticated

the communication has become.

There have been several attempts to fully

automate the secondaries market over the

years. could that ever really work?

Groen: There are people who have been working

on this for years and years, but for anything

other than the most basic LP interest trade,

automation just isn’t possible.

van Zyl: Ultimately, third-party consent is

required. You can matchmake as much as

you like, but the deal is still at the discretion

of the GP.

Mash: That type of automation doesn’t even

really work on the high-yield bond market.

While secondaries houses have been quick

to emphasise their countercyclical nature and

the opportunity the financial crisis presents

for the industry, top of the market secondaries

portfolios have been hit hard. how severe are

these portfolio problems, and might we see

some secondaries houses disappearing as

many now expect primary firms to disappear?

Gardey: More than anything, what we will see

is more specialisation. We now have direct

secondaries firms, there are also firms focusing

on venture, on mezzanine, and there are firms

like Pomona that focus more on the mid-market.

That trend will continue. But where we do

anticipate some consolidation is among the

fund of funds and non-traditional secondaries

players that have wandered into the market.

atterbury: My view is that there will be some

poor performers from 2006 and 2007 vintages,

and that could create a knock-on effect when

it comes to raising future funds. Yes, the market

is growing and evolving, but there is no doubt

some groups will be challenged and that

fundraising will be incredibly tough.

and can you guarantee that this

time next year, we won’t still

be asking whether the

secondaries market is

finally going to take off?

atterbury: I can say

with some confidence

that we expect 2010

to be the year of the

secondary.

secondaries

“we really compete against alternative forms of sale. sellers are infrequently distressed but often strategic. they have choices and we must provide better value”