Q&A With a Secondaries Buyer: “We’re Making Specific Bets on Companies”

Following last week’s interview with secondaries intermediary, Colin McGrady of Cogent Partners, here is the other side of the coin: A Q&A with the buyside. I’ve spoken with David Tom, a Vox Populi contributor and investment pro at VCFA Group, a buyer of middle market secondary interests in LBO, mezzanine and VC funds.

Will Q4 numbers make much of a difference in valuations?

I think they will. Not that we’re pricing off of the GP’s valuations, but investment committees and sellers will. So if we’re telling them to take a loss, it’s different than the fund manager telling them to take a loss. It’s true that we don’t care what the GP’s valuation is, but it helps negotiating a deal. Deals can collapse when it gets to the investment committee. Either way, we won’t get Q4 numbers until February or so.

Does that give you an incentive to wait to do any deals?

From our perspective, we’re still going to do the work, but we’re realistic in it taking longer to close deals.

What does pricing look like now?

People are reassessing the bids once again. There was a point with a lot of auctions where first round bids came in high and the second round came in higher. That has changed. Now first round bids are low and the sellers are just hoping the buyers will stick around.

So, since it’s such a buyers market, is your firm pickier about what it will bid on?

From our perspective, we hadn’t participated in many auctions in the past. The readjustment in the market caused us to enter into a number of them because we thought there was a better chance of getting a good price. And a lot of our competitors backed out of the market. I think some of them were waiting for Q4 numbers, and they still are.

What’s attractive right now?

We’re not trying to make sector bets or macroeconomic bets; we’re making specific bets on companies. We know some other firms will hedge their positions, possibly by shorting securities, and we don’t do that.

There are certain businesses we’ve seen that are doing reasonably well in this economy. They have very inelastic demand. Even in a bad economy, we have portfolio companies that are doing really well. Defense industry is one sector that has been less impacted so far. Every once in awhile you run across a mission critical company that its customers can’t cut. Those are few and far between but they do exist. The challenge is if you are like us, then your primary business is buying funds. If there’s a portfolio with two great companies, and three potential zeros, it’s hard to be interested.

Is increased interest in the space driving prices up?

More commonly, the investor gets the offer and says “no thank you.” They think they can get more for it or they can’t convince their committee they have received a fair price. If its 60% or less, they think they’re getting taken advantage of, but that may be the average price for secondary deals. Then again, there are not a lot of deals closing.

Any surprising things happen lately?

We’ve been increasingly getting calls because secondaries have been in the news so much. We’ve gotten a lot of calls from people in hedge funds, wondering how they can take advantage of this, or people who are wondering how they can buy some of the underlying portfolio companies.