Daniel Green of Greenpark Capital talks secondaries

Could you explain how you have seen the secondaries market grow since you have been involved in the market?

“If you go back to September/October time, there was a lot of volatility in the markets. Lehman Brothers collapsed and that left to a lot of banks potentially following them down that path. Before governments around the world stepped in, we saw a number of financial institutions, not just banks, come to market trying to shop their private equity assets on the secondary market. In the last quarter of 2008 we saw a huge uptick in deal flow.

It is comparable to the surge in deal flow at the time of the tech bubble.  At the time, a lot of people needed to get out of venture funds. High-net-worth individuals, who on paper were worth a heck of a lot of money, had committed huge amounts of cash, could not fund their commitments and were, therefore, screaming to get out of these venture funds. We saw a huge increase in deal volume back then. That was back in between 2001 and 2003, and we were investing our first fund back then. However, we did hardly any venture at all. Even though the deal flow peaked, we did not take advantage of it as that is not our focus. After this, secondaries kept growing.”

What do you see happening now?

“Volatility and major financial events on a macro level create secondaries deal flow. Investors were in desperate search for cash in Q4 last year and this created a lot of potential deal flow. We saw a huge uptick during this period and we have closed a few deals off the back of this – one with a bank that we got a great discount on. And then the governments stepped in and started supporting the banks. At that point, although they were still looking for cash, the banks did not have to accept the prices that were on offer. The pricing by buyers at this time was very low as their perception of risk was very high. Because of this, you did not transact unless you really needed to. So the only sellers were those that were extremely liquidity motivated.  That is why, although a lot of people in Q1 and Q2 have tested the market, there have been a number of transactions which came to market and a number of potential buyers declined. So deal flow at one point was looking like it was on the up when in fact the number of transactions is very low. I do not think there has ever been a period before when so many deals have fallen over, or, at least, not even got off the ground. There is such a big difference between what people are ready to accept as regular sellers as part of their portfolio management programme and what they are forced to accept as distressed sellers.

What we have seen over the last few weeks is plenty of transactions, but small ones. Our sweet spot is between €15m and €20m per transaction, but we partake in anything from €1m to €50m. The kind of deals we are seeing now are liquidity driven events. You can ask, ‘why didn’t these distressed sellers sell earlier in the year?’ and I think the answer is that GPs were busy doing deals. They are coming back to market now. We are seeing capital calls coming in now, and GPs who want to make capital calls. While they may have been patient earlier in the year, they are now saying ‘if you’re an LP of mine and you have got an issue or it looks like you’re going to have an issue settling on a call notice, then we’ll see if we can work something out.’ Of course you have the big headlines of big state pension funds that are unable to meet capital calls. Now that is changing and some people have sorted their positions out, but for a lot of people nothing has changed – they have not had any distributions, they are still over-committed and in some cases they are highly leveraged. These people are finding that now the calls are coming in they cannot escape the reality any more and have to find a solution. The solution is one of two stark choices: they can either default or sell. It is expensive reputationally to default but, if you are not bothered by that, you may go down that route.

However, a GP will do their best to preserve their capital base. We have had a lot of calls from GPs from across the industry who are looking to replace LPs who they have known about as being a problem for a while and who are likely to go into a defaulting process. They are approaching us saying ‘we have these guys that we think are going to default soon and they have expressed their interest in a secondaries sale. Can you guys come in and speak to them?’ We are looking at closing a couple of deals of that ilk right now and I think that is going to increase.

More people will feel the pinch and be looking for sources of capital, and where that is not available they will have to look to secondaries.   We are expecting there to be an increased level of activity in the second half of the year. A big increase. The first half was pretty slow.

If you look around you will see that people are saying there is a huge amount of deal flow out there right now - $120bn by some estimates - which is just not realistic. The reason for those big numbers that people bandy about is that a lot of that money is commitments that are not a majority drawn and that is something we would never look at. It might be deemed a secondary to have a 20 per cent funded commitment, but this is not the type of secondary that most dedicated secondary outfits will buy. Some people will specialise in picking up unfunded pieces, such as funds of funds that have the capacity and can step in to a commitment that is 20 per cent drawn, effectively getting it for free with a GP that they like. But there will be a lot of positions like that which people will not want to buy. That is something we have seen. So of the $120bn, $80bn or $60bn or whatever you believe that number to be, a big chunk of that is deal flow that most secondaries-dedicated players would never do. Most secondaries players would only go with funds that are 50, 60 or 70 per cent drawn.

Having said that, we still think that potential deal flow over the next 12 to 24 months is going to be extremely attractive. Some of the stuff out there right now is great value, and we are pricing conservatively.”

Are you seeing different types of buyers coming into the market to take advantage of opportunities? If so, do you think these types of buyers are going to have an impact on secondaries specialists?

“We have seen buyers come in that are not dedicated to secondaries who think it is an easy game to play. They bid the market price or just over the market price to get an interest in fund X. The reality is that that is a very dangerous game to play and people have had their fingers burnt doing so. You really have to do intense due diligence and look at each underlying asset in the portfolio very carefully. You cannot look at it top down in terms of the fund’s market pricing, whether it is trading at a premium, etc. You have to look at each underlying asset and what they are going to sell for in the future. And that is a very time intensive process. Buying secondaries is not a trading style investment.”

So you do not think these sorts of buyers are going to push secondaries-specific buyers out of the market?

“No, because if you want to do it properly, you have to have the expertise to do it effectively. Sure, if you want to go out on an ad hoc basis once in a while and take a piece that you come across, I am sure people will be able to do that – and sometimes they will do well. Other times they will do badly. But if they want to do it properly, they will need the expertise and I do not see those types of buyers doing that. Having said that, it makes sense for an LP if they missed the boat on a manager in a  2007 or 2008 fundraise, the fund is 20 per cent called and they can pick it up from a distressed investor for next to nothing. Why not? It is a no-brainer if they like the manager, like their strategy. Although people dabble, these types of buyers are not a threat to secondaries players.”

Do you expect to see different types of secondaries transactions coming up?

"It could be that we see transactions that bypass the fund investors themselves. If a fund is already fully tapped out and the assets still need funding, you need to get more money from somewhere. Unless you have exceptionally good banking relationships, it is likely that you will have to sell a slice of that portfolio to a secondaries purchaser and then put the money from the deal back into the companies, leaving you with a healthier portfolio. This is effectively like a refinancing. Some GPs are going to find it tough to raise funds over the next couple of years, and they will look to the secondaries market to supply capital.

There are also the banks’ private equity assets. A lot of banks have assets sitting on their balance sheets which, when you look at capital ratios, are expensive to hold. The banks want to make money from lending money, if they can. They could be earning a heck of a lot more money from lending money than the assets they are hanging onto are worth. Banks will be looking to sell portfolios because of this.”

Do you use intermediaries to source transactions and, if so, how do you think they add value?

“We are very capable of sourcing deals in Europe ourselves and, therefore, are not reliant on intermediaries.

However, we have done a number of deals in the US and continue to look there on an opportunistic basis. Out there we have contacts that bring us transactions. The US is quite a competitive market already for secondaries and it is efficiently intermediated, so by using buy-side guys out there we often see good deals. There are big purchases available and anything over a certain size is going to be intermediated by someone like a Cogent Partners, a UBS, or a Credit Suisse. Intermediation is a bit more of an integral part of the process in the US. It is harder to be an intermediary in Europe. If you look at typical intermediary transactions in Europe, they are different to those in the US. We do not have a CalPERS or any of these big state pension funds with 300 different LP interests. It is a lot more fragmented in Europe, which means that you get smaller deals and these are less worthwhile taking on if you are an intermediary.”

What is you opinion on electronic exchanges for secondaries?

“I have seen a lot of secondaries exchange platforms such as this come, and seen a lot of them go. I have seen secondaries grow from a relatively small market in 2001 when Greenpark started, to a sizable one. In the early days we saw NYPPEX try an exchange, and that did not work. Then we saw Triago set up TriagoX, which was an attempt at a secondaries exchange. That did not go anywhere. At the moment you have Second Market. I do not want to make any forecasts about how they are going to do.

The issue with these types of exchanges is that you have a lot of rules. First of all, LPAs (limited partnership agreements) are covered by confidentiality restrictions. I cannot see that many GPs will be happy seeing positions in their fund get released on these kind of exchanges. Although I think that since these are private exchanges, they may be covered. People who access information on the exchange will have to sign up to a confidentiality agreement. That would be a way round it.

Also there are rules about trading in the US. You are not allowed to make a private instrument a tradable instrument. I guess the question that comes with these exchanges is ‘are these private instruments now deemed to be tradable instruments?’. There are some question marks that surround these platforms and will determine their success. But who knows? It is an interesting approach.”

What do you think will happen in the secondaries market going forward?
 
“We are already seeing certain areas mature from the early days in the mid-nineties when the secondary market was a very niche area of private equity. Over the last couple of years  secondary transactions have become fairly standard. There used to be a stigma attached to secondaries where a GP did not want the stigma of a secondary having taken place in their fund as it raised questions, such as ‘Why would anyone want to sell a stake in your fund?’. Now lots of people accept that it is just one of those things that happens and that limited partners simply have to manage their portfolios. You will see secondary transactions becoming an evermore accepted practice.

A lot of the market is relatively underserved. It is still difficult for some people to transact, despite the number of secondaries players out there. If people are not able to carry out their transactions, this tells you that it is not a massively competitive industry yet and there is still plenty of opportunity out there.”  

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