20SecondaI BUYOUTS 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 capital call 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. buyout 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 Western Europe. to divest their private equity holdings.” v~othuyoutsnews.com December 13,20101 BUVOUTS 121 COVER STORY Secondary Market Rising (Annual Deal Volume) B 25 20 $1 5B 0= 15 $1 3B 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 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: Preqin Indeed, record low pricing was a huge the new circumstances, especially com “tourists.” These are institutional investors obstacle to deal-making last year. prevent pared to what could have happened to like pension funds and sovereign wealth ing all but the most desperate sellers from them.” funds that have traditionally invested completing transactions. For most of last The secondary market is clearly already through the primary market, but are seeing year, secondary buyers were only interested beginning to feel the impact of better more attractive opportunities in the second in purchasing private equity holdings at prices. Nicklas at Lexington Partners said ary market. “Instead of waiting for firm X to half their net asset value, and almost that 2010 was an extremely hectic period come out with a new fund in two years, nobody wanted to sell for that cheap, result for his firm. In the first nine months alone, these guys are seizing the chance to get in ing in low deal volume. the firm completed seven transactions total right now through the secondary market,” In fact, a number of highly publicized ing approximately $2 billion. “This was the said Jean-Marc Cuvilly. managing partner at transactions fell through in 2009 because busiest time we ever had,” he said. The Triago. buyers and sellers could not agree on pric finn’s biggest transaction was the $1.2 One such investor is China Investment ing. Stanford University cancelled plans to Citibank deal. Corporation (dC), China’s sovereign wealth sell up to $1 billion in private equity hold fund, which roared into the secondary mar ings on the secondary market, while Capital Supply Growing ket this year with $1.5 billion to spend. The Columbia University put the brakes on a Not only are there more sellers in the upside for CIC is the ability to invest in well- $600 million portfolio sale. market these days, there are also more buy established funds it might not have had Today prices have perked up consider ers. Given the growing level of activity in access to otherwise—and likely at a dis ably. with buyers on average agreeing to a the market, it_s not surprising that new count. slight discount of about 10 to 20 percent, players are trying to get a foot in the door. “The universe of buyers is no longer just according to Triago. With the economy sta “In the wake of the downturn, some pri a handful of secondary funds you hear bilizing somewhat, both buyers and sellers vate equity firms were not able to raise new about in the press,” said Cuvilly. “The num have greater confidence in near-term valua funds. Those partners are now looking ber of potential buyers has grown from tions. They are in a better position to see around for what to do next,” said Byers of about 30 usual suspects eight years ago to common ground and complete deals. VCFA Group. Clearly, some have come to some 400-plus buyers today.” “I think some sellers are looking back at the conclusion that the secondary market is Meantime, traditional players have plen the depth of the downturn and are just the hot place to be. “We are seeing some ty of capital to spend themselves. Newbury happy they didn’t get wiped out,” said Brett new boutique funds, but they’re not a real Partners recently closed a new $1 billion Byers. a managing director at VCFA Group, factor yet,’ said Byers. fund to capitalize on the opportunity. Other which specializes in buying secondary posi The secondary market is also playing secondary firms with new funds include tions. “They are more inclined to sell under host to a number of’ 1iobbyists” or Lexington Partners, which just raised more 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.