Kline Hill Partners makes private equity investments in the secondaries market, with a focus on the smaller end of the sector.
The company’s founder and managing partner, Michael Bego, spoke to Buyouts about his company’s strategy and how it is dealing with the coronavirus pandemic.
What’s behind Kline Hill Partner’s strategy regarding smaller deals in the secondaries market?
We’re trying to provide value to the underserved secondaries portion of the private equity market. We feel that small deals and the sellers of these fragmented packages of funds are underserved. It’s much more difficult to find a good quality counterparty or one who won’t just give you a good price, but will also give you senior-level attention, hold your hand and then, if you do a transaction together, give you white-glove service to close a deal.
The smaller side of the market has seen a lot of activity lately because of Covid-19. Do you worry that the market will be saturated with players going after small deals? Where does Kline Hill fit in?
At Kline Hill, we’ve been living in a world of over-saturation. We’ve done almost too much of a good job in the past on working well with sellers and providing good value. We’re getting so many deal introductions and referrals. Every single day we’re getting several actionable deals. We’re one of the most active in the whole industry, but we can only do a deal or a deal-and-a-half every week and that’s more active than almost every other secondaries fund. If we’re doing 60 to 70 deals a year, that’s the very highest end of activity.
What’s Kline Hills’ response to the disruption caused by covid-19? Any change in how you approach deals?
Absolutely. Most secondaries funds shut down their business of buying LP interest. We don’t believe in timing the market. We raised a fresh pool of capital and the first thing was to let people know that Kline Hill is open for business and has been open for business amid covid-19. The second thing was covid-19 obviously had a tremendous impact on the business world and how different types of industries function and it may have a long-term impact on how these businesses will continue to function.
We have a Kline Hill covid-19 scoring system, which is an approach that we put together that walks through every single company that we’re buying. We’re screening entire portfolios.
On one hand, we have our traditional valuation approach, in which Kline Hill does bottoms-up valuations on all these underlying assets, but we layer on top of that the Kline Hill covid-19 score. What it tells us is how virus-resistant a business is. If you think about it, there are sectors that may have more or less impact. Restaurants and retail shops were hit more, but some technology firms may actually be better off.
We find the lines of business that they’re in, alongside the specific type of businesses, to come up with a score. Secondly, we’ve adopted our entire methodology to analyze and incorporate the impact of the virus on business, so that we’re making intelligent decisions from an investment standpoint. The third thing is, internally we’re obviously focused on the health of the team and the people that we work with. All three have been a big success.
Deal volume has been lowered this year because of the coronavirus, but there will eventually be an uptick. What do you think that will look like?
The secondaries market froze, with volume dropping 80 percent to 90 percent as soon as the virus kicked in and the lockdown started. We have almost the same deal flow as we did before. Overall, the secondaries industry is going to become unglued when the statements for the second quarter come out around Sept. 1.
It’ll be the busiest quarter that we’ve ever seen in the industry. What’s been holding up the buyers is all the uncertainty around valuations and how businesses will do. They’re waiting for the GPs to tell them how things are going to happen and progress and for updated valuations to show up in the Q2 statement. There are a lot of sellers sitting on the sidelines because of big discounts, but the discounts will shrink for two reasons. They’ll shrink because the values will be lower for Q1 and Q2, so you don’t need as big of a discount. Two, we’ll have much more visibility of what the world is going to look like we as we come out of lockdown.
What are sellers in the market saying about what’s happening right now?
The ones that we’re executing with have different types of cash needs. Some really want to get liquidity out for their portfolio management or operating businesses or for security. I think they know that valuations today are lower than what they were prior, but they’re looking for comfort that the lower price that they get is still a fair market value, which is why Kline Hill is a good fit for a lot of them because we’re doing deep, bottoms-up work and we have the Kline Hill covid-19 score. They want to know that they’re getting a fair price, even if it’s a low price.
Life isn’t always perfect, but you want to know that you’re getting treated like everybody else is or treated fairly based on circumstance.