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Private Equity Investments Are Going to Lose Value. How Much Is Anyone’s Guess.
General partners will likely draw out markdowns over several months, leaving investors to make their own assumptions about the true value of portfolios.
As private equity firms finish out the first quarter of 2020, investors are bracing for their investments to be marked down. The only problem is, they likely won’t know how far valuations have dropped for a few more months.
“When there’s a quick downturn like this, the privates won’t get marked for two months,” Brad Alford, founder of search consulting firm Alpha Capital, said by phone.
Alford and other investment professionals say that re-valuing assets takes time on top of the usual post-quarter work that private equity firms do. How private equity firms will choose to revalue those assets is also a question mark, which means limited partners are left to make their own assumptions until they get solid numbers from their money managers.
“What we’re seeing now is GPs are re-underwriting their deals to examine the assumptions they made on assumptions related to EBITDA, cost of capital, cost of credit, and exit multiples,” Alan Kosan, senior vice president at outsourced-CIO firm Segal Marco Advisors, said by phone Friday.
According to Preqin data released on March 31, investors can expect “muted returns” for buyout funds with vintage years between 2012 and 2017. Net multiples and internal rates of return will also impact exit valuations and timelines, the data firm said.
Private investment data provider CEPRES said Thursday that it is advising clients to use a 10 percent value at risk metric to estimate how much value a portfolio can lose. Meanwhile, Julian Gervaz, chief executive at online secondaries marketplace Palico, forecasted “20 to 40 percent discounts overall compared to pre-coronavirus pricing.”
“I was talking to a private equity guy recently who said there are some portfolio companies that are worth nothing now,” Alford said. “Is a general partner really going to mark it to zero?”
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However bad portfolio companies are hit, experts suggest that discounts likely won’t come all at once.
“An OCIO just told me the write-downs are going to be so bad in private equity funds in the first quarter that many general partners plan to do them over two quarters to smooth the returns,” Alford said. Jim Scheinberg, founder of North Pier Search Consulting, made a similar observation.
“There will probably be several rounds of markdowns on the private equity side,” he said by phone Thursday. “You’ll get markdowns from this initial wave because valuations are going to come in from the public market.”
Some investors are looking to past financial crises for guidance on how to act now.
According to Scheinberg, private equity investments with vintage years 1999, 2006, and 2007 underperformed because valuations were high leading up to both the dot-com bubble burst and the 2008 financial crisis.
“It is likely that private equity will see a similar pattern with 2018 and 2019 vintages,” he said. “But that depends on the virus and how long and deep the economic crisis is right now.”
Kosan had another take on the situation.
“In 2008 and 2009, you had a financial sector meltdown that had systemic, broad-reaching impacts,” Kosan said. “Now the financial sector so far is not the issue. It’s well-capitalized, well-regulated, and they have cash on hand.”
This time, he said, things are different, as there’s a pandemic coupled with a market drop that could turn into a recession or even depression.
“It's a one-two punch,” Kosan said. “It's not that you can look at cleaning up the financial sector and going back to normal. This has to be a far bigger cleanup process.”