UBS Private Equity Secondary Market Review UBS Private Funds Group June—2011 UBS Private Funds Group Secondary Market Review The UBS Private Funds Group’s Secondary Advisory Practice was launched in 2004 with the mandate to provide the highest quality sell- side advice to owners of private equity portfolios. In the current installment of this series, UBS provides a comprehensive review of secondary market activity in 2010 and the first quarter of 2011 and highlights key issues and trends that will impact the secondary market in 2011. Our perspective is unique within the secondary market, based not only on our experience as a leading placement agent and secondary advisor, but also as a seller in the structuring and execution of UBS’s own $1.3 billion secondary transaction in 2003.1 To date, UBS has advised on and executed over $24 billion of secondary transactions and has established itself as a market leading advisor.2 Review of the Secondary Market—2010 Market Environment Secondary volume rebounded to record levels in 2010, totaling approximately $22 billion which represented a 132% increase as compared to 2009 levels ($9.5 billion).3 The combination of improved capital market conditions and strong levels of available capital resulted in a dramatic improvement in the pricing environment during the first quarter of 2010, while increased regulatory pressure crystallized financial institutions’ intention to sell risk assets. Following a somewhat slow start to the beginning of 2010, the year began to pick up momentum following the announcement of Bank of America’s $1.9 billion transaction and RBS’ €400 million transaction. These transactions were particularly noteworthy given their size, which seemed to signal that both sellers and buyers were comfortable making large “splash trades”, a feature clearly missing from the market in 2009. The large “splash trade” theme continued through 2010 and has carried forward into 2011, as there have already been eight transactions greater than $500 million brought to market in the first half of 2011.3 However, dry powder declined in 2010 for the first time since 2006, a feat that may be repeated in 2011 with expectations for at least another $20 billion in transaction volume. While there is sufficient dry powder among secondary buyers and capital markets conditions are buttressing pricing levels, technical supply and demand factors could impact pricing / competition later in 2011, particularly with so many large secondary buyers fundraising. Pricing Trends4 After ending 2009 at an average discount of (31.6%) for buyout assets and an average discount of (36.8%) for all assets, pricing improved meaningfully during the first quarter of 2010 to an average discount of (12.1%) for buyout assets and an average discount of (12.5%) for all assets. Thereafter, pricing seemed to stabilize to modestly improve throughout 2010 ending the year at an average discount of (11.7%) for buyout assets and an average discount of (15.5%) for all assets. Thus far in 2011, pricing has been relatively unchanged from fourth quarter 2010 levels, except for buyout pricing which increased to a (3.0%) discount. QUARTERLY PRICING FOR PRIVATE EQUITY ASSETS 0.0% (3.0%) (8.2%) (7.5%) (10.3%) (10.0%) (12.1%) (13.4%) (9.8%) (11.7%) (13.1%) (12.5%) (18.0%) (17.2%) (15.5%) (20.0%) (18.1%) (25.0%) (21.1%) (26.5%) To find out more about UBS’s (31.6%) (30.0%) dedicated private equity secondary (34.0%) (30.9%) market advisory services, please contact: (33.9%) % (Discount) to NAV to (Discount) % (36.8%) (40.0%) (36.9%) (38.8%) Nigel Dawn (50.0%) Managing Director, Global Co-Head Q4 '09 Q1 '10 Q2 '10 Q3 '10 Q4 '10 Q1 '11 UBS Private Funds Group +1-212-821-5333 All PE Buyout Venture Energy [email protected] Source: UBS-advised transactions; based on the average of the high bids received Pricing Trends (continued) 45 days for interim financial statements, 9.30 financial Pricing for energy funds is also particularly notable as statements tend to become stale. More specifically, GPs the average discount price for energy focused funds are able to provide guidance on year-end valuations in was better than buyout funds for the 2nd, 3rd and 4th advance of the completion of the audit process which quarters of 2010. Energy appears to have developed buyers are able to reflect in their pricing relative to the into a thematic investment for select secondary buyers. 9.30 NAVs. With many large buyout funds predicting In addition, many secondary buyers have been double-digit write-ups to 9.30, optical pricing particularly attracted to US energy funds due to the expectedly increased as buyers incorporated the new inherent barriers to entry created by tax leakage that information into their analysis. makes it harder for non-US buyers to acquire these Transaction Volume interests at market clearing levels. Secondary market volume was approximately The stable to modestly improving “optical” pricing $22.0 billion in 2010, representing a 132% increase levels evidenced during 2010, despite rising net asset from 2009 levels.3 In addition, transaction supply values (“NAV”), suggests that buyers’ expectations increased to $27.5 billion from $16.3 billion in 2009, regarding future performance were improving representing an increase of 69% (note that UBS’s throughout the year. As a result, sellers that waited transaction supply likely understates the actual until later in 2010 to execute transactions generally transaction supply as the data generally captures only received increased purchase price proceeds. However, intermediated transactions and publicly announced as the table demonstrates, determining the optimal non-intermediated transactions).3 The disparity between time to sell should not be exclusively predicated on the increase in transaction volume and transaction whether increased purchase price proceeds were supply suggests that transaction completion rates generated. For example, sellers that sold during the increased dramatically in 2010, which is not surprising second quarter of 2010 based on a December 31, 2009 given pricing levels. reference date and invested the purchase price proceeds in the S&P 500 would have been in an equal SECONDARY TRANSACTION VOLUME to better than position than the sellers in the third and 25.0 22.0 fourth quarters of 2010. Moreover, this analysis does 20.0 not make any adjustments for risk which would further 20.0 skew the analysis towards second quarter 2010 sellers. 15.0 15.0 9.5 10.0 TIMING OF SALE DECISIONS (US$ bn) Reference Date 5.0 Sep-09 Dec-09 Mar-10 Jun-10 Marketing Period Q1 '10 Q2 '10 Q3 '10 Q4 '10 0.0 Closing Date Mar-10 Jun-10 Sep-10 Dec-10 1 2007 2008 2009 2010 Reference Date NAV 188.81 202.86 215.84 225.51 2 (% Discount)—Buyout Funds (12.1%) (18.1%) (13.4%) (11.7%) Base Purchase Price 165.88 166.20 187.01 199.04 1 Post-Reference Date Net Cash Flow 5.02 0.22 (4.97) (13.95) Source: Publicly available data and UBS estimates Cash Received at Closing 170.90 166.41 182.04 185.09 3 S&P 500 % Change from Closing Date to 06/30/10 (11.86%) 0.00% n/a n/a As mentioned previously, market conditions allowed for 3 S&P 500 % Change from Closing Date to 09/30/10 (2.41%) 10.72% 0.00% n/a 3 S&P 500 % Change from Closing Date to 12/31/10 7.54% 22.02% 10.20% 0.00% a greater number of large transactions (greater than 4 Cash Position at 06/30/10 150.63 166.41 n/a n/a 4 Cash Position at 09/30/10 166.78 184.25 182.04 n/a $500 million in transaction value). In aggregate, there 4 Cash Position at 12/31/10 183.79 203.05 200.62 185.09 were at least eleven transactions in 2010 that were Notes: 1 Based on a hypothetical portfolio consisting of equal weighted commitments to large buyout funds greater than $500 million as compared to only three in 2 Based on the average of high bids received during the applicable Marketing Period 3 3 Based on FactSet 2009. Although financial institutions and US public 4 Cash Position asssumes Cash Received at Closing is subsequently invested in the S&P 500 state plans / public agencies were the sellers for eight While the quarterly pricing data has generally been and three of the largest transactions in 2010, relatively stable, the first quarter of 2010 and 2011 data respectively, their rationale for selling was quite reveal that the market experienced material changes in different. For financial institutions, it was regulatory “optical” pricing levels, particularly for buyout funds. reform and for state agencies / public agencies, it was While there are many factors contributing to the portfolio management. change in optical pricing levels, a chief contributor is the “year-end phenomenon.” This phenomenon, which is most likely to occur during the first two to three months of every year prior to the release of year-end audited financial statements, is amplified during periods of changing macroeconomic conditions. With year-end audited financial statements sometimes taking up to 120 days to be finalized instead of the customary 30 to 2 2007/8/9/10 TRANSACTION VOLUME BREAKDOWN— LGT, which together raised approximately 50% of the FUNDS AND DIRECTS dedicated capital.5 Additionally, 2010 saw increased focus on separate accounts as several large sovereign 25.0 wealth funds, seeking to capitalize on the benefits of Directs the asset class and current market opportunity, sought 20.0 17% Directs to partner with leading secondary buyers.