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The secondaries market’s black swan

The economic shock caused by the coronavirus is already filtering into the asset class.

For a decade, investment professionals have wondered when the market cycle would finally turn and for what reason. Enter covid-19. The immediate effect of the virus on the secondaries market has been marked; its medium-to-long-term impact, difficult to gauge.

No more walking the factory floor

Travel bans are making in-person diligence almost impossible, leading to an increase in stalled GP-led processes, particularly single-asset deals, sister title Secondaries Investor understands after speaking with around a dozen market sources in March and April. At least four GP-led deals are struggling to progress amid the crisis.

A big advantage of portfolio trades is the reduced importance of face time. Diligence to a certain extent can be done from the safety of one’s desktop, and at least one participant expressed the hope that a successful period of enforced video conferencing might, in the long run, lead to a reduction in unnecessary travel.

Still, pricing expectations are diverging.

“You can price a portfolio from your couch with a laptop and a phone, but no one will sign a $300 million deal over Skype,” says one New York-headquartered advisor.

Valuations in the air

The difficulty in getting deals done is compounded by the fact that GPs are still working out how public market declines and the drop in oil prices will impact first-quarter and second-quarter valuations. There will be write-downs, but by how much and in which assets?

“Any business that has some kind of supply chain or has short-term liquidity requirements is going to suffer,” says one London-based buyer. “There is potential [growth] for businesses that encourage you to stay at home: Netflix, teleconferencing software … for good companies this is a short-term hit” and could prove a “great buying opportunity.”
Lawyers from Paul, Weiss, Rifkind, Wharton & Garrison shared that positivity, noting delayed exits could lead to an eventual uptick in GP-led activity.

Sellers holding back

Sellside sources say that while high-quality portfolios are still changing hands, pricing expectations diverging. Anticipating a big reduction in March NAVs, a number of opportunistic sellers paused transactions. According to Pomona Capital CEO Michael Granoff, they will likely be replaced by “motivated sellers” driven by liquidity needs or PE over-exposure.

“That will probably be a good opportunity for us, but I don’t think that rotation will happen [evenly],” he says. “We may see the exit of the first group before the entry of more motivated sellers.”

Negotiate, renegotiate

There has been an increase in buyers looking to renegotiate deals and take a second stab at underwriting in light of declining public-market comparables: “Some of our counterparties are saying ‘you have to close, we agreed to it’,” says one Asia-based buyside source. “We’re saying ‘circumstances have changed’ … We think there may be delays in some business plans of two-to-four quarters.”
Volatility can create a potential goldmine for savvy buyers – just look back to the global financial crisis. Of course, that wasn’t accompanied by a pandemic. In the words of one veteran sellsider: “I can’t remember a time when entire countries have just shut down … it’s unprecedented.”

Rod James is a senior reporter with sister titles Secondaries Investor and PEI