Valuing secondaries in the private equity market is an intricate task, influenced by myriad factors and subject to market subjectivity and external uncertainties. The interplay of these complexities, coupled with the volatility of public markets, paints a fascinating trajectory of where secondary prices have been and where they stand today.
1. Volume Trends:
Addressing the volume aspect, recent times have witnessed a dip in demand for secondaries, particularly in growth and early-stage companies. The fundamental principle of supply and demand comes into play, indicating that fewer buyers naturally lead to lower prices. This decline is driven by factors such as risk mitigation strategies employed by funds and disagreements between buyers and sellers on pricing.
2. Capital as a Non-Issue:
Contrary to common belief, the reduction in volume is not primarily attributed to a lack of capital. Examining the "dry powder" metric, which represents cash on hand for funds to invest, reveals a significant spike in the past year, as depicted in the graph below. While ample capital exists for future deals, the current hesitation to invest suggests that investors are adopting a cautious approach, preferring to wait for more favorable opportunities.
3. Secondary Transaction Trends Over Time:
Delving into the historical context, secondary transaction volume experienced an 18% drop in 2022, reaching $108 billion from the previous year's record of $132 billion. The first half of 2023 continued this trend, with volume falling to $43 billion, marking a 25% decrease compared to the same period in 2022. The graph below illustrates the muted secondary transaction volume in the first half of 2023.
4. Pricing Realities Today:
Examining current pricing reveals a downward trend relative to past years. LP portfolio pricing for buyout and venture capital, despite rebounding from the second half of 2022, still remains on the lower end historically over the last five-plus years, standing at 90% and 69% of reference NAV, respectively. This trend suggests that as valuations adjust to new macroeconomic realities, discounts are likely to shrink, albeit presenting potential advantages for secondary buyers. This shift is also reflected in valuation multiples, with the median global EV/EBITDA multiple dropping from 11.4x in 2017 to 10.5x in 2023.
5. Factors Influencing Pricing:
The precise reasons for the current decline in pricing are multifaceted. As valuations slowly adjust to account for the new macroeconomic reality of higher rates, discounts are anticipated to shrink. The calculation of secondary market discounts, relative to NAV, can be deceiving during periods of valuation flux. It is crucial to recognize that the discount to the intrinsic value of assets within a fund, rather than just the headline discount to the last reported NAV, is a more significant factor for potential buyers seeking optimal returns.
Conclusion:
Navigating the intricate landscape of private equity secondaries requires a deep understanding of valuation challenges, market dynamics, and investor behavior. As volume trends reflect a reduction in demand and capital remains abundant but underutilized, the evolving market scenario suggests a cautious yet opportunistic approach for investors waiting on the sidelines. The coming months will likely witness a recalibration of the private equity secondary market as confidence in pricing returns and investors seize more favorable opportunities in this shifting landscape.
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