Secondary Pricing Analysis

Interim Update, Summer 2009

Cogent Closes Over $2.5B in Transactions –
Less Than 20% Purchased by Secondary Funds

By Colin McGrady, CFA

Brad Heffern
 Secondary Pricing Analysis Interim Update, Summer 2009 1

Secondary Pricing Analysis Interim Update, Summer 2009

Cogent Closes Over $2.5B in Transactions – Less Than 20% Purchased by Secondary Funds
By Colin McGrady, CFA
Brad Heffern

Executive Summary 7. Over 50% by value of the funds transferred in

the first half of 2009 went to first-time buyers.
The secondary market for private equity has played
a key role in providing liquidity to institutional
8. Market knowledge is more valuable than ever in
investors, allowing them to rebalance asset
achieving the optimal valuation and meeting
allocations and acting as a source of liquidity.
timing constraints in secondary transactions.
Pricing of private equity in the secondary market fell
in concert with other asset classes in 2008, but did it
Data Sample and Methodology
recover along with the public equity markets in the
first half of 2009? A review of the pricing and trends This study analyzes the bids that Cogent Partners
in the secondary sales Cogent represented in the received on a diverse group of more than 200
first half of 2009 revealed the following findings: partnership interests marketed from January
through June 2009, representing more than $2.5B in
1. Pricing for all funds was 45.1% of the transaction value. The funds marketed represent a
12/31/08 NAV. diverse range in fund types (61% buyout funds, 22%
venture funds, and 17% other funds). As always, the
2. Pricing strengthened over the half-year, with bids represent first-round bids. Consistent with the
bids based off of 12/31/08 NAVs coming in methodology used in previous pricing studies, in
higher than would be justified by write-downs cases where bidders submitted a pricing range in
when compared to 9/30/08 bids. lieu of specific numbers, the midpoint of the range
was used in the analysis. Continuing the trend noted
3. Large amounts of unfunded capital had a in the second half of 2008, many binding first-round
substantial effect on pricing, though the bids were requested for portfolios or fund assets
direction of the impact was opposite for buyout marketed in the first half of 2009, whereas first-
and venture funds. round bids had been almost exclusively non-binding
prior to 2008.
4. 2006 and 2008 vintage funds received
surprisingly good pricing, while 2007 funds One positive side effect of increased media
received much worse pricing than any coverage is an increased interest in buy-side
other vintage. participation in the secondary market. As such,
bidders during this period were diverse. While the
5. Over half of the high bids were received bidder profile in the data set differs from that in past
from non-traditional secondary buyers, who studies, Cogent remains confident that the bids
are approaching the secondary market in an are indicative of the price that could be achieved
opportunistic manner as a way to improve the for the funds. This confidence stems both from
return profiles of their primary portfolios. the historic performance of first round bids and
ultimate transaction values from buyers in Cogent-
6. The non-traditional buyers were diverse, with led transactions, and because this data set contains
pensions, insurance companies, family offices, more binding first round bids and bids from single-
endowments, foundations and general partners stage processes than any previous data set.
all participating in transactions.
2 Secondary Pricing Analysis Interim Update, Summer 2009

Fig. 1 Secondary Bid Spreads (H1 2009)

60%

55%

50% Average High

B
Average Median
45%
Average Low
% NAV

40% B B
B
35%

30%

25%

20%
All Buyout Venture Other

Private Equity Categories

Table 1 Pricing Dispersion H1 2009

0% Bids High Bids <20% High Bids >60% Highest Bid

% of Funds
All 7% 17% 13% 102.0%
Buyout 8 20 12 100.0
Venture 4 17 13 102.0
Other 5 5 21 86.0

Secondary Market Prices Continue 2008 Trend
As the effects of the weakening economy cascaded
through the financials of private equity portfolio
companies, pricing for the funds continued to
weaken as a percentage of the stale reported NAVs.
For the first half of the 2009, the average high bid (the
simple average of the highest individual bid received
for each asset) across all assets in the sample was
39.6% of the NAV of the funds’ most recent financial
statements, with an average median bid of 35.7% of
NAV and an average low bid of 31.6% of NAV (Figure
1). This pricing level represents a continuation of the
pricing decline for secondary transactions observed
in 2008, when pricing fell from above NAV in 2007 to
61.0% in the second half of 2008. Prices have fallen
to the lowest levels seen since the publication of
this analysis (Figure 2).
The decline in pricing is not specific to fund types,
though venture funds did achieve slightly higher
pricing than buyout funds in this sample with an
average high bid of 39.4% of NAV, an average
median bid of 37.7% of NAV and an average low bid
of 33.9% of NAV. The average high, median and low
bids for buyout funds were 37.7% of NAV, 33.0% of
NAV, and 28.8% of NAV, respectively.
Pricing as a Percentage of the Year-End Valuation
While the above analysis is consistent with the
methodology used in previous first-half pricing
analyses, the volume of prices received early in the
year (prior to the availability of the general partner
year-end valuations) and the level of markdowns
taken at the end of 2008 versus previous years
skews the pricing considerably. This effect can be
seen by disaggregating the pricing by the quarterly
statements the funds were priced against. Funds
priced off of the year-end numbers achieved an
average high bid of 52.4% of NAV, while funds priced
prior to the release of the year-end financials had
 Secondary Pricing Analysis Interim Update, Summer 2009 3

Fig. 2 Secondary Bid Spreads Over Time (H1 2009)

120%

110%
B
B
100%
B
90%
B Average High
B
80%
% NAV

70% B

60% B Average Median

50%

40% B Average Low

30%

20%
2003 2004 2005 2006 2007 H1 2008 H2 2008 H1 2009 H1 2009
As a % of
12/31 NAV
Bid Spreads By Year

Table 2 Unfunded Impact on Pricing

Average High Bid (% of NAV)

<50% Funded >50% Funded

Buyout 27.2% 42.7%
Venture 51.7% 36.0%

an average high bid of 38.1% of the 9/30/08 reported
NAVs. When those NAVs are adjusted for the write
downs taken at year end, the pricing improves
to 44.1% of the subsequently released year-end
financials. The delta between the bids based off
of 12/31 NAVs and the bids originally based off of
9/30 NAVs and rolled forward to 12/31 may indicate
that secondary pricing had actually improved by the
time 12/31 financial statements began becoming
widely available. Further bids received after the
first half of 2009 also suggest that secondary pricing
is improving.
Pricing is Asset Specific
While overall pricing levels certainly declined in
the first quarter, pricing for funds continues to be
primarily driven by the underlying assets in the
portfolio, not typical trading ranges for particular
GPs. Table 1 details the pricing level dispersion
for the funds in the survey. Even amidst the broad
decline in pricing, the highest value received for
a buyout fund was 100.0% of NAV, while the most
highly valued venture fund was priced at 102.0% of
NAV. However, only 12% of the buyout funds and
13% of the venture funds priced above 60% of NAV.
At the other extreme, 17% of the funds received a
high bid of 20% or less of NAV. In these instances,
it was not that the underlying investments were
deemed to be nearly worthless, but that the bidders
required a discount of nearly the full NAV to assume
large unfunded commitments associated with the
funds.
Unfunded Capital Has a Dramatic Effect on Pricing
Given the liquidity squeeze that has been affecting
nearly every institution since the beginning of the
downturn, more highly unfunded partnerships were
4 Secondary Pricing Analysis Interim Update, Summer 2009
Fig. 3
2005 and Earlier
2006
2007
2008
0% 5% 10% 15% 20%
Average High Bid (% of NAV)
marketed in the first half of 2009 than in any other
time in recent memory. While it can be argued
that, with highly unfunded partnerships, pricing
as a percentage of NAV is less meaningful, the
perceived liability of unfunded commitments has
caused buyers to place, and sellers to accept, lower
bids as a percentage of NAV.
For buyout funds, Cogent found a discrepancy of
more than 50% between funds less than 50% called
and those more than 50% called. These funds had
an average high bid of 27.2% and 42.7% of NAV,
respectively. However, venture funds that were
less than 50% funded actually had significantly
higher pricing than funds greater than 50% funded,
at 51.7% and 36.0% of NAV, respectively. This
additional discount applied to mature venture funds
is likely explained by concerns that the funds will
not have enough capital to protect positions in the
anticipated future financing rounds of the portfolio
companies. Therefore, the general partners will
either invest in those companies in subsequent
funds, or need to raise annex funds to protect their
position.
Vintage Year Matters
While pricing was relatively consistent in the mid-
40% range for funds with vintage years of 2005 and
earlier (representing nearly 50% of the sample),
Vintage Year Pricing
25% 30% 35% 40% 45% 50%
pricing for 2006-2008 funds was more interesting.
Pricing for 2006 and 2008 funds, at 39.7% and 41.3%
of NAV respectively, was actually significantly
higher than might be expected. However, pricing
for 2007 funds was abysmal at 26.1% of NAV,
approximately 40% lower than the pricing for 2005
and earlier vintages. This may be explained by
the fact that, while 2006 funds may have made bad
investments and 2008 funds have large amounts of
unfunded capital, 2007 is the only vintage which has
both issues.
Achieving the Best Price – Know the Market!
The most striking data from the pricing analysis
comes from a review of the profile of the winning
bids for the funds marketed. As losses have
rolled through private equity funds, many of the
traditional secondary buyers, both dedicated
secondary buyers and active fund-of-funds buyers,
have changed their behavior considerably. These
buyers, who have traditionally represented the
bulk of buyers in the secondary market, have
become much less aggressive with pricing and
much more selective in the funds they are willing
to price at reasonable levels. At the same time,
a large number of non-traditional buyers have
ventured out of their core competency of primary
investing, and are purchasing secondary fund
interests. Cogent maintains ongoing dialogues and
 Secondary Pricing Analysis Interim Update, Summer 2009 5

Fig. 4 Transaction Value by Buyer Type

Dedicated Secondary (17.2%)

Non traditional (43.1%)

Fund-of-funds (39.7%)

secondary interest lists with institutional investors, Transaction Trends

and was able to achieve the best pricing from these
In this fluid financial environment, the nature of
institutions in 43% of the funds sold during the first
marketed transactions has changed. One significant
half of the year. This effort was broad, with only one
change is the nature of assets buyers are willing,
non-traditional buyer purchasing funds in more that
or unwilling, to bid on. Potential buyers are much
one transaction, and over 20 buyers purchasing only
more selective in the assets they are willing to price,
one fund interest during the first half of the year.
or price reasonably. This has led to an increase in
the number of buyers involved in transactions, or
The non-traditional buyers that Cogent was able
put a different way, a decrease in the number of
to enlist in its transactions were diverse, with
funds a bidder purchases in each transaction. In
pension funds purchasing approximately 37% of
2007, a buyer of a market portfolio purchased 6.1
the funds, and insurance companies, family offices,
fund interests on average, while for the first half
endowments and foundations all purchasing a
of 2009, the average number of funds purchased
double-digit percentage of the funds sold to non-
by a successful bidder fell to 2.2. While this adds
traditional buyers.
complexity to the sale process from marketing to
closing, it indisputably creates value for the seller.
This ability to achieve the best pricing for our
In previous years the demonstrated benefit of
clients demonstrates clearly the added value
selling to multiple bidders rather than the highest
of the approach Cogent Partners has taken to
single bidder in a transaction was an incremental
developing the secondary market. By performing
10%. The 177% increase in the average number
the underwriting, understanding the assets, and
of buyers for a similarly sized transaction over the
being able to drive interest with non-traditional
past two years has dramatically increased the
secondary buyers, our clients have achieved far
value of selling to multiple buyers over the previous
better pricing than they would have received simply
incremental uplift in value.
marketing to the large secondary buyers. Further,
Cogent’s expertise in driving the closing process is
even more beneficial when both the purchaser and
seller are unaccustomed to the transfer process.
6 Secondary Pricing Analysis Interim Update, Summer 2009

Fig. 5 Non-Traditional Buyer Types

GP (9%)

Foundation (11%)

Pension (36.8%)

Endowment (11%)

Family Office (15.8%)

Insurance (17.5%)

The Value of Deep Market Knowledge seller to close is viewed as a sign of weakness that
only further erodes pricing. The current environment
It can be unequivocally stated that the economic
has increased the importance of knowledge of
rationale for institutions seeking liquidity in the
buyer preferences, bidding history and transaction
secondary market to use an informed advisor has
strategy in executing a successful secondary sale.
never been more compelling. Institutions that
negotiate either with only one or a small number of
Considering these market facts, it is not surprising
potential buyers and thus receive large portfolio bids
that the most sophisticated market participants
are leaving money, terms, and transaction timing on
are seeking the market expertise and assistance
the table. This point is made by the secondary buyers
of intermediaries. With the pricing insight, market
themselves, which in their fund marketing materials
knowledge, and process and negotiation expertise
universally point to proprietary deal flow as a signal
an experienced advisor can provide, institutional
of superior returns. This fact is emphasized by
investors can intelligently look to the secondary
the data in this study as well, in which dedicated
market to help achieve liquidity and rebalancing
secondary buyers were the high bid on only 17% of
needs in their portfolio.
the funds, and no single dedicated secondary buyer
was the high bid on more than 4% of the funds.

The increased complexity needed to maximize

pricing magnifies the importance of market
knowledge and proper transaction management in
a successful secondary sale. Bringing a portfolio to
market by approaching two or three large bidders,
hoping their competition will drive the best price,
leaves significant value on the table. Further, when
timing is of concern, recent detailed knowledge of
which buyers, and specifically which non-traditional
buyers, are pricing certain assets aggressively is
of great value. Unrepresented sellers in exclusive
or limited conversations have seen buyers delay
transaction timing, while any pressure from the
Cogent Partners has advised institutional investors on over $30 billion of private equity secondary
transactions since the firm’s founding. Through its research-driven, analytical approach to the secondaries
market, Cogent Partners assists the most sophisticated institutional investors in achieving their objectives
and fulfilling their fiduciary duties.

If you are interested in a confidential discussion of your alternative asset portfolio paths to liquidity, with
detailed insight into pricing for assets you would consider selling, or other avenues to generate liquidity,
please don’t hesitate to contact us. All conversations are held in the strictest confidence.

Colin McGrady, CFA

Mr. McGrady is Managing Director in the firm’s Dallas office, and is a co-
founder of Cogent Partners. Colin has advised clients on large asset sales,
structured transactions, and recapitalization of securitized private equity
vehicles. In addition to client engagements, Colin developed and oversees
Cogent Partners’ annual pricing analyses.

Prior to co-founding Cogent Partners, Colin worked at The Crossroads

Group, a $2B private equity fund of funds. He began his career at Bain &
Company, working in the private equity practice in both Dallas and Tokyo.
Colin earned an MBA from Harvard Business School, a BA in economics
with a Japanese minor from Brigham Young University, and is a CFA
charterholder.

Brad Heffern
Mr. Heffern is an associate in the firm’s Dallas office and works in Cogent
Partners’ Research Business Unit, performing portfolio analysis and
valuations, and assisting in client engagements. He joined Cogent Partners
in 2005.

Mr. Heffern holds an AB in mathematics and economics from the University

of Chicago, and has passed all three levels of the CFA program, with a
charter pending necessary work experience.
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