By Douwe Miedema and Simon Meads
LONDON, Nov 23 (Reuters) - Specialist buyers of secondary
private equity investments are in a perilous business, as
bargains now may soon prove to be rip-offs, with a mountain of
assets looking set to be dumped on the market.
Perfectly sound second-hand private equity assets can be had
for a 30-percent discount and more questionable ones for no
money at all, fund-of-funds investors say, but the uncertain
outlook makes pricing a hazardous game.
"A lot of people would say it's like trying to catch a
falling knife," said Elaine Small, a partner in charge of
secondary private equity operations at Paul Capital, a
specialised private equity investor.
"We would rather pay a full and fair price for companies
with (strong) characteristics than get a big discount on a
company that's going to go bankrupt," she said.
The credit crisis last year put an almost immediate halt to
leveraged buy-outs, the bulk of the business for private equity
houses, but the secondary market remains lively as large
investors offload their exposure.
Capital available for secondary deals -- what the industry
calls dry powder -- is about $12 to $15 billion, said Small,
whose company manages some $4.2 billion of secondaries.
Yet assets coming onto the market in the next one or two
years of as much as $130 bln in the financial services sector
alone would dwarf that figure, she estimates.
Small's figure does not include assets being sold by pension
endowments, such as Harvard or Duke universities which have
recently put private equity assets up for sale.
Another prominent seller not part of the figures is the UK's
Wellcome Trust, a charity trust funding medical research, which
has invited bids for part of its 3.8 billion pound ($5.64
billion) private equity portfolio.
BARGAIN HUNTING
Secondary buyers insist there are enough healthy assets out
there -- only a small portion are from distressed situations,
where a company is in financial trouble.
Large institutional investors may need to sell private
equity assets as their exposure exceeds their own guidelines,
after poor performance of their equity portfolios. Other
investors simply need the cash.
"For strong funds, discounts are 25 percent or more. For
funds with less than perfect reputations, discounts are 40
percent or more," said Bob Long, Chief Executive of Conversus
Capital, a fund-of-funds firm.
"For funds with real challenges, today, you can buy some of
those funds for virtually no initial outlet capital," Long said,
just by vowing to fund future capital calls.
Secondary investments are a way to keep doing business, even
as the primary private equity players are sitting on their cash
and looking for alternative ways to make money.
Conversus -- spun off from Bank of America -- has been
investing money roughly at the same rate as before the credit
crisis and money returns from its portfolio have been stable
this year, though much lower than a year ago.
But markets take a sceptical view and Conversus' shares are
trading at a 43-percent discount to its Net Asset Value (NAV),
according to its own data, in line with rivals.
The discount of Partners Group Global Opportunities is 61
percent, Conversus says, JP Morgan Private Equity Limited trades
at a 21-percent discount and Lehman Brothers Private Equity is
67 percent below NAV.
SELL IF YOU CAN
There is little from inside the world of primary private
equity investors to stop the market gloom.
Limited partners, or investors in private equity funds,
often resist accepting a discount, but they may get used to the
idea later this year when managers have revalued NAV and they
have a realistic valuation in front of them.
Assets might be trading at a significant discount to
valuations made at the end of June, but things may look even
worse when compared with likely valuations at year-end.
And while selling at a loss may hurt, it does allow
investors to get off the hook for future commitments to funds,
said Billy Gilmore at Scottish Widows Investment Partners
private equity fund of funds business.
"It's a lot better to take what you can for that exposure
and have some dry powder to invest in what seem to be more
attractive conditions in the future," he said.
(Editing by Chris Wickham)
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