Are PE secondary prices recovering too fast?
Neuberger Berman today sent over its annual private equity outlook report, which included an argument that private equity fund trades (i.e., secondaries) are “still attractive relative to historical levels.” For evidence, it presented the following chart:
Neuberger Berman clearly has a leg to stand on here, since we’re nowhere near the absurd premiums being paid just before the financial market collapse. In fact, we’re not even quite at 2004 levels, which is just before the so-called “golden age” of private equity began.
At the same time, however, there should be some concern about the valuation rebound’s velocity. I know this largely is reflective of the public equity markets, but average high bids (as a percentage of NAV) rose nearly 52% between 2009 and 2010, and over 102% between 2008 and 2010.
For context, the Dow Jones Industrial Average has risen around 76% from its four-year low (March 2009) through the end of 2010. And, remember, that’s based off of a single nadir — not by averaging an entire year of activity.
I guess that this boils down to a simple question: Do you believe that private equity — both its primary and secondary investing spheres — exercises pricing discipline?
Neuberger Berman clearly believes that it does. In another part of its report (not secondaries-specific), it writes: “Private equity managers will need to maintain their pricing discipline as recent rises in public market valuations and greater availability of credit have begun to drive transaction multiples somewhat higher.”
I’m not so sure. To me, “pricing discipline” is something people exercise actively, not reactively. It’s very different to bid at 80% of NAV because that’s what you honestly believe is a reasonable figure, as opposed to bidding 80% of NAV because you don’t believe the deal can be financed at a higher percentage (or if you don’t believe the company will sell at a lower one).
I worry that private equity has been more reactive over the past several years, both in good times and bad. “Buy low, sell high” was replaced by “buy high and sell higher,” until such a strategy was forced into hibernation by uncooperative lenders. Now it’s making a comeback, partially driven by expiring investment periods for funds raised in 2006 and 2007 (use it or lose it, in many cases).
If Neuberger Berman is right about pricing discipline, then next year’s report shouldn’t show anything above 90% of NAV for average top bids in 2011. But I’d be surprised if that’s the case…
Here is the entire Neuberger Berman report:
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