20SecondaI I December 13.2010 vnnv.buyoutsnews.com arket Poised To Lift Off

ByTom Stein

Sellers Proliferate Secondary buyers have been predicting big Indeed, it’s no secret that financial insti tutions have their backs to the wall, They things for their market for some time. Now it are under increasing regulatory pressure to finally seems to be coming to pass. restrict their exposure to private equity. Governments and financial regulators are hammering out new rules, including Basel III and the Volcker Rule in the United States, After a dismal 2009, in which only $8 bil ing to investors a potentially cheaper and which will make private equity investing a lion worth of private equity assets were trad more liquid way to get exposure to private lot less attractive for financial institutions ed on the secondary market, 2010 is shaping equity. For LPs, an active market means an and possibly even prevent them from creat up to be a record year. Total volume for the opportunity to snap up some bargains, ing their own private equity vehicles. year is expected to reach $25 billion, easily either by directly purchasing secondary This year saw the start of some of that surpassing the previous record of $15 billion positions or by investing in secondary funds. unwinding, with AXA PrIvate EquIty pur set in 2008, according to private equity advi What is the bullish case for the second chasing part of Bank ot America’s private sory firm Triago. ary market? For starters, Richard Lichter, equity portfolio for $1.9 billion. The deal For investors like David de Weese. a part managing partner at secondary investment was the largest transaction on record in the ner at secondary buyer Paul Capital, this is firm Newbury Partners, estimates that there secondary market. That transaction was just the tip of the iceberg. “I could see the is now roughly $1 trillion in unfunded pri closely followed by news that Citigroup was market going to $30 billion or $40 billion vate equity commitments. This is bad news selling $1.2 billion worth of private equity next year,” he said. “There are huge oppor for many cash-strapped investors, including investments to secondary specialist tunities developing and they are beginning banks, that are looking to unload their posi Lexington Partners. “This is just the start,” right now.” tions. After all, the last thing they need right said de Weese. “You are going to see one Indeed, both general and limited part now is a from the likes of The bank after another in this market.” ners need to be prepared for a flood of sec Blackstone Group or Kohlberg Kravls Sc The new regulations will be phased in ondary deals in coming months, and their Roberts. “Rest assured, those calls are com over the coming decade, which means that impact. For GPs, a rapidly expanding second ing,” said Lichter. “And when those capital most buyers are not anticipating any fire ary market could mean a revolving door of calls do go out, holders of private equity are sales just yet. But they do expect a steady investors. Time will have to be spent evalu obligated to meet them.” flow of deal-making over the next several ating and approving new investors, as well In addition, de Weese and others see a years. as educating them about the investment number of financial services firms under the “We really saw the regulatory issues take strategy of the fund. It means that fund per gun to unload the bulk of their private equi hold this year and spark activity,” said Brent formance becomes an open secret if second ty holdings. All told, de Weese believes there Nlcklas, a managing partner at Lexington ary transaction prices get leaked to the pub is an eye-popping $300 billion to $400 bil Partners. “On top of that, pricing was up this lic. And, in raising new hinds. shops lion of private equity exposure that needs to year compared with last year, so banks were will increasingly have to compete for capital be unwound by large banks in the United in financial position where they could afford with secondary buyers who will be promot States and . to divest their private equity holdings.” v~othuyoutsnews.com December13,20101 BUVOUTS121 COVERSTORY

SecondaryMarket Rising (AnnualDealVolume)

B 25

20

$15B 0= 15 $13B 4. =a) $108 10 $8B $78 $7B $8B

5 $3B $38 $28 $28 $1B $18 $18 SIB

— I I I I I I P I I I I 0 1995 1996 19971999 1998 2000 2001 2002 20032004 2005 2006 2007 2008 2009 2010

Source:Preqin

Indeed,recordlow pricing was a huge the new circumstances, especiallycom “tourists.”These areinstitutional investors obstacleto deal-makinglast year.prevent pared to what could have happened to like pensionfunds and sovereignwealth ing all but the mostdesperatesellersfrom them.” funds that have traditionally invested completingtransactions.For most of last The secondarymarketis clearlyalready throughthe primarymarket,but areseeing year,secondary buyerswereonly interested beginning to feel the impact of better moreattractiveopportunitiesin the second in purchasing privateequity holdings at prices.Nicklasat LexingtonPartnerssaid arymarket.“Insteadof waitingfor firm Xto half their net asset value, andalmost that 2010 was anextremelyhectic period comeout with a new fund in two years, nobodywantedto sellfor that cheap,result for hisfirm. In the first nine monthsalone, theseguys areseizingthe chanceto get in ing in low dealvolume. thefirm completedseventransactionstotal right now throughthe secondarymarket,” In fact, a number of highly publicized ing approximately$2billion. “Thiswasthe saidJean-MarcCuvilly. managingpartnerat transactionsfell through in 2009because busiesttime we ever had,”he said.The Triago. buyersand sellerscouldnot agreeon pric finn’s biggest transaction was the $1.2 Onesuchinvestoris China Investment ing. Stanford Universitycancelledplansto Citibankdeal. Corporation (dC),China’ssovereignwealth sellup to $1billion in privateequityhold fund,which roaredinto thesecondarymar ings on the secondary market, while CapitalSupply Growing ket this yearwith $1.5billion to spend.The Columbia University put the brakes ona Not only are there more sellersin the upsidefor CICistheabilityto investin well- $600million portfoliosale. marketthesedays,therearealsomorebuy establishedfunds it might not have had Todaypriceshaveperked upconsider ers.Giventhe growing level of activity in accessto otherwise—andlikely at a dis ably.with buyers onaverageagreeingto a the market, it_snot surprising thatnew count. slight discountof about 10 to 20 percent, playersaretrying to getafoot in the door. “Theuniverseof buyersis no longerjust accordingto Triago.With the economysta “In thewakeof the downturn,somepri a handful of secondaryfunds youhear bilizing somewhat,both buyersand sellers vateequityfirms werenot ableto raisenew aboutin the press,”saidCuvilly.“Thenum havegreaterconfidencein near-termvalua funds. Those partners are now looking ber of potential buyers has grown from tions.Theyare in a better positionto see aroundfor what to do next,” said Byersof about30 usualsuspectseight yearsagoto common groundandcompletedeals. VCFAGroup.Clearly,somehavecometo some400-plus buyerstoday.” “I think somesellersarelookingbackat theconclusionthat thesecondarymarketis Meantime,traditionalplayershaveplen the depth of the downturn and are just the hot placeto be. “We are seeingsome ty of capitalto spendthemselves.Newbury happytheydidn’t getwiped out,”saidBrett new boutiquefunds,but they’renot a real Partnersrecentlycloseda new $1 billion Byers. a managingdirectorat VCFAGroup, factoryet,’ saidByers. fundto capitalizeontheopportunity.Other which specializesin buyingsecondaryposi The secondarymarket is also playing secondaryfirms with new funds include tions.“Theyaremoreinclinedtosellunder host to a number of’ 1iobbyists” or LexingtonPartners,whichjust raisedmore 22 BUYOUTS December 13,2010 ~w~.bt~,outsnewscom Ups, Downs Of Secondary Fundraising

30 — Aggregate Commitments —-— No. Funds Raised

25 25 22.7B

20 20 = = C B 15 15 a a, a = =~I1 9.7B 10 10 ~- a, In CD 6.GB C- 5 5

0 0 2010 YTD

Source: Preqin

than $5 billion, its largest fund to date. And “You saw a large number of secondary roaring back very quickly,” said Cuvilly. AXA Private Equity is targeting up to $4 bil funds raise big pools of capital and they With growing competition, it’s incum lion for its newest secondary fund. had trouble putting it to work in 2009,” bent on pure-play secondary funds to sepa If anything, such funds are under even said Cuvilly. “The theory was that ‘09 rate themselves from the pack, or risk get more pressure than the more opportunistic would be a great year because you could ting squeezed out. This could mean taking entrants to put capital to work and start pick up assets cheaply.” That never hap an innovative approach that no one else is doing more deals, especially after an anemic pened, however, and secondary funds real following. For Paul Capital, innovation is 2009. Triago’s Cuvilly estimates that second ized they had to make up for lost time, or coming in the form of emerging markets. ary funds still have about $50 billion in dry face the specter of handing back money to The firm recently established offices in Sao powder. their investors. “That when pricing came Paolo and , and is now allocating fully 20 percent of its $1.65 billion fund to emerging market opportunities. Historic Secondary Pricing as % of NAV “We are the only secondary buyer from Mexico City to Buenos Aires. so we have a 120% whole continent to prospect in,” said Paul Capital’s de Weese. “We have seen some very attractive deals.” The firm typically buys secondary positions from local devel opment banks, companies and 90% - wealthy families who often have no idea they can sell their private equity holdings on the secondary market. The strategy has proven so successful that some of Paul 60% - Capital’s LPs are asking the firm to allocate an even larger percentage of the fund to these deals. “At the moment, we don’t have a lot of competition, so we can be very 30% — selective about what we do,” said de Buyouts Weese. Venture Given the changing dynamics of the sec

I I I I I I I I I ondary market, k’s very possible that 2011 0 Dec-06 Dec-07 Jun-08 Sep-08 Dec-OS Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Current will provide even greater opportunities. “I pricing think everyone expects to see continued

Average DIP - VIntage 1998—2008 growth in the market,” said VCFA Group’s Byers. Now it’s just a matter of buyers and Source: Preqin sellers agreeing on the right price.