There’s more than one way to get a piece of the cheaper-than-thou private equity secondary market these days. You can invest in a traditional fund, like the ones I outlined earlier this week. Or, you can buy some shares of a public fund-of-funds that targets PE secondaries.
Conversus Capital is the largest such option. The firm underwent a $1.9 billion IPO in 2007, using the proceeds to invest in the secondary interests of 168 funds and has since added 49 for a current tally of 217 funds. The idea is that shares of Conversus give you immediate and permanent exposure to the secondary market, whereas an investment in a traditional fund is spread over five to ten years.
Today Conversus’ market cap has shrunk to $456.3 million and it’s written down the net asset value of its portfolio by 50%. However, the firm hasn’t seen its capital calls outweigh its distributions, thanks in part to its mere 5% allocation to mega-funds. I spoke with CEO Bob Long yesterday about market timing, mega-funds, his firm’s stock’s performance, and what happens if distributions freeze.
Has the firm benefited from the recent interest in secondary market?
We have seen some investor interest from those who are attracted to the secondary market opportunity today and recognize the benefits of investing at deep discounts while getting the capital immediately deployed in a permanent capital vehicle such as ourselves. With Conversus, you can get a pretty clear view into our portfolio and the discount to NAV that you hope to benefit from.
Can you explain how that works exactly?
Unlike traditional fund-of-funds, we raised capital once, in our IPO. We take the cash flow from our existing investments and reinvest it. Because we started with a portfolio on the upswing of the J-curve, our portfolio was still cash-flow positive in 2008, with more distributions than calls. The key is that we are unlike a fund-of-fund who goes out and gets commitments and then invests those, calling the capital over a period of time, waiting for the assets to mature be realized. We are more like a REIT for PE assets. We take the cash flow from the existing portfolio and re-invest it.
Isn’t there a risk that a few bad eggs could drag down the entire portfolio?
Were we to be more concentrated, that would be a possibility, but we are highly diversified. We have 121 GPs in 217 funds across the buyout, venture and distressed strategies with about 2,000 underlying portfolio companies.
So what are benefits of owning stock in a public fund of funds?
The positives are the ability to be fully invested, to have transparency and liquidity, and public company governance. Most investors can get liquid if they need to, over reasonable time periods. It’s a huge advantage over regular private equity fund of funds. Also, investors can avoid the administrative inconvenience of capital calls and distributions.
What about the negatives of this structure?
One negative is the stock price can become disconnected from actual net asset value. That’s what we’re experiencing now. Our stock is trading at about 30% of our December net asset value, or a 70% discount. You may remember the Cogent report said the secondary market is trading at 35% to 40% (a 60% to 65% discount) to NAV. So we’re even trading at a discount to the secondary market.
The entire financial sector has taken a beating in the stock market in the past year, but it would seem that, with the intense interest in secondaries of late, that your stock would have performed better. Any ideas as to why that is?
In my opinion, the stock reflects the cloud over the private equity space, along with the performance of our peers, many of whom are trading at even deeper discounts to NAV. Moreover, it’s a lack of understanding of our strengths and the quality of our portfolio. For example, we aren’t exposed to the ’06 and ’07 mega funds of $7.5 billion plus that have captured a disproportionate share of the headlines. They only make up 5% of our portfolio, and we have taken some meaningful writedowns already. (Ed. note: The breakdown is available here)
Do pension funds and other institutional investors categorize Conversus stock as part of their alternatives portfolio? Because at the end of the day it is a public security-shouldn’t it be in that basket?
Most investors appear to consider us to be part of the alternatives bucket as opposed to the public stocks bucket. Conversus has been used as a tool to reach the alternatives allocation and be nimble in adjusting that exposure up or down. Right now we’re obviously in a world where “down” seems to be more popular than “up.”
The exit market is looking grim for ’09. What happens if there are no distributions?
That’s a valid point. We have a credit facility provided by Citigroup through 2012 and it is an essential part of the business model. We were cash flow is positive in 2008 and even in February, but overall, capital calls and distributions are much lower over recent months and we expect them to remain at low levels in 2009. It is important to have other sources of liquidity to meet capital calls. We have been able to do that thus far through cash flow of the portfolio on balance.