Marketing communication – For professional investors only
Secondary transaction volumes have been increasing, helped by a stabilizing market backdrop, a persisting need for liquidity by LPs as a result of slower distributions, and as valuation expectations between buyers and sellers continue to converge.
But a narrowing of bid-ask spreads is not, on its own, a reliable indicator of value. So, looking ahead, where will the biggest opportunities lie for investors in secondary transactions?
Secondary Volumes May Hit a New Record High
Transaction volumes in the first half of 2023 did not look promising as they continued to be impacted by a stubborn bid-ask spread. As the year progressed, however, average pricing levels stabilized and rebounded slightly from the decade-low levels in 2022. Together with a narrowing bid-ask spread, this provided renewed confidence to market participants and triggered a surge in completed secondary transactions.
Kristof Van Overloop, Managing Director at Flexstone Partners, an affiliate of Natixis Investment Managers and a lower mid-market buyout specialist, says: «We are currently working on several mid-market deals and have been seeing some really motivated sellers now.» Whereas the bid-ask spread was closer to 10 percentage points last year, it has since narrowed to 3 percent to 4 percent allowing more deals to get done. «Many potential sellers were testing the waters last year. But over time and continued stubbornly lower distributions, they have now become keen to sell on the secondary market to generate much-needed liquidity».
Providing Exposure to Trophy Assets at Attractive Discounts
GP-led transaction volume is well-positioned for further growth in an environment of continued slower exit activity and increased LP appetite and need for liquidity. This is increasingly driving GPs to approach the secondary market, launching continuation funds to deliver liquidity options to their LPs and improve from their funds.
Top quality, or so-called trophy assets, are being brought to market, says Van Overloop. «We completed a handful of GP-led transactions last year involving such assets at attractive entry valuations, resulting in substantial day-1 write-ups for us as a buyer, while still allowing to lock in solid returns in the GP’s original fund.» GPs are willing to sell these outperforming assets because they have typically outperformed their original underwriting case and fulfilled the objective for the fund. Secondly, these funds are often fully invested and lack the available capital to continue to support a portfolio company that requires further capital to accelerate organic or bolt-on M&A growth.
Selling LPs are accepting a meaningful discount to the latest reported value or intrinsic value, but may still be getting a good exit and – more importantly in the current market – are getting liquidity. Despite not achieving price maximization, approximately 80 percent of LPs chose liquidity and elected to sell into continuation funds in 2023, roughly in line with recent years.
As a consequence, secondary buyers such as Flexstone can get exposure to coveted assets with strong GP alignment and a substantially de-risked value creation trajectory. Asset and manager selection remains critically important though. «Our targeted and selective investment approach focused on partnering with GPs with whom we have close and longstanding relationships, allows us to select and only pursue those GP-led opportunities where we have differentiated insights and where we can position ourselves favorably to secure our desired allocation,» says Van Overloop.
The increasing share of (lower) mid-market GP-led transactions positions Flexstone well for continued strong deployment to this secondary transaction type.
Lower Competition, Less Intermediation, and More Inefficiencies to Exploit
The smaller end of the secondary market, with ticket sizes below €50 million, is characterized by lower competition and low to no leverage, resulting in more attractive pricing levels. Several of Flexstone’s historical peers have raised ever larger funds over the years and have moved into higher deal brackets, now targeting much larger portfolio transactions.
Van Overloop says: «We have remained disciplined with consistent and relatively small fund sizes and have stayed true to our DNA with ticket sizes of about €15 million to €25 million on average.» As a result, Flexstone can remain highly selective and choose only the high-conviction deals it wants to pursue. This stock-picking-like approach is a very different way of approaching the market compared with the deployment pressure faced by large-cap secondary funds that cannot afford to be as selective, encouraging aggressive bidding behavior and higher pricing.
- Read the full article here
Written in March 2024
Additional Notes
Marketing Communication. For professional investors only. Past performance is not indicative of future results. All investments involve risk, including the risk of capital loss. The provision of this material and/or reference to specific securities, sectors, or markets within this material does not constitute investment advice, or a recommendation or an offer to buy or to sell any security, or an offer of services. Investors should consider the investment objectives, risks and expenses of any investment carefully before investing. The analyses, opinions, and certain of the investment themes and processes referenced herein represent the views of the portfolio manager(s) as of the date indicated. These, as well as the portfolio holdings and characteristics shown, are subject to change. There can be no assurance that developments will transpire as may be forecasted in this material. In Switzerland: This material is provided by Natixis Investment Managers, Switzerland Sàrl, Rue du Vieux Collège 10, 1204 Geneva, Switzerland or its representative office in Zurich, Schweizergasse 6, 8001 Zürich.
NATIXIS INVESTMENT MANAGERS Paris 453 952 681 Capital: 178 251 690 € 43, avenue Pierre Mendès-France, 75013 Paris www.im.natixis.com
FLEXSTONE PARTNERS, SAS – Paris. Investment management company regulated by the Autorité des Marchés Financiers. It is a simplified stock corporation under French law with a share capital of 1,000,000 euros Under n° GP-07000028 –Trade register n°494 738 750 (RCS Paris). 5/7, rue Monttessuy, 75007 Paris. www.flexstonepartners.com
FLEXSTONE PARTNERS, SàRL – Geneva. A manager of collective assets regulated by the Swiss Financial Market Supervisory Authority (“FINMA”). It is a limited liability company with a share capital of 750 000 CHF. Trade register n° CH-112-212.153.- 8 chemin de Blandonnet. Vernier 1214 Geneva. Switzerland
