Click here for printer friendly page

Institutional investor profile: Geoffrey G Clark and J Christopher Kojima, Managing Directors and Michael J Brandmeyer and Harold P Hope III, Vice Presidents, Goldman Sachs Private Equity Group

The Goldman Sachs team on the growth of direct (or synthetic) secondary transactions, on the need for liquidity in the private equity market, on the increasing sophistication of sellers and on why auctions don't always fetch the best price.

Based in New York and London, the Goldman Sachs Private Equity Group manages approximately $10.5bn in capital commitments across primary partnership commitments, co-investments, and secondary investments. The group invests across the spectrum of private equity sectors around the world. Clark, Kojima, Brandmeyer and Hope are the Portfolio Managers of the Firm's secondaries funds. Clark is also a co-founder of Goldman Sachs Private Equity Group. Kojima is also the Co-Chief Operating Officer of the Private Equity Group.

What type of secondary investments do you look for?
Clark: ‘We look at secondaries transactions across all forms of private equity type and strategy - buy-outs, venture, mezzanine, distressed. We look at both limited partnership secondaries, where we buy a position in a fund, and at portfolios of direct investments, which we refer to as “synthetic secondaries”. The important commonality across any form of potential secondary is that we take a principal approach to valuing the opportunities, which involves examining the underlying business fundamentals of each company exposure combined with a risk-managed approach to portfolio construction. It doesn't matter whether it is a limited partnership secondary, a portfolio of direct investments, venture, or buy-out - the approach is always the same.'

Kojima: ‘We take this principal-oriented approach because our experience suggests that this is the most successful way of making secondary investments, especially in current market conditions. In the past, many secondary buyers tended to price transactions by applying a rule-of-thumb discount to funds' net asset values (which are often out of date, and can be based on subjective measures). This “top-down” approach can work well when markets are rising, but in volatile markets such an approach can easily over-value assets.

‘Our view is that a successful secondary market buyer cannot rely on valuations supplied by GPs or the portfolio companies themselves, but instead needs to take a view on the industry outlook, examining the company fundamentals and analysing financial and operating projections. Only by taking this detailed approach can you arrive at something close to an accurate or fair valuation of a portfolio. This takes a large, experienced and dedicated team.'

How important a consideration is the management team when you look at fund investments?
Brandmeyer: ‘The quality of the managers is very important in two respects. First, the general partner continues to drive value in the existing portfolio of underlying companies, making operational improvements, enhancing management teams, and optimising strategy. Second, in many secondary transactions, there are unfunded commitments where the quality of the manager is crucial in determining how those commitments will be invested. To be sure, there is a price for nearly everything in the secondary market. Dependence on the GP can be mitigated if the partnership interest is acquired using a creative structure or by buying at any attractive price.'

Do you have a preference for mainly funded positions?
Hope: ‘We clearly have a preference for partnerships and portfolios of directs that are more funded than unfunded, since this allows us to better evaluate the underlying company investments. There is no hard and fast rule, but we generally prefer opportunities that are at least 50-60 per cent funded.'

Do you have a geographic focus?
Clark: ‘We think of geographic exposure in two ways: the location of the sellers and the domicile of the underlying company investments. For sellers, we have been fortunate to have developed relationships worldwide - in Europe, in Asia, and throughout the Americas. With respect to the assets, we tend to see more opportunities among private equity assets based in the Americas or in Western Europe. The more limited exit opportunities and some of the structural challenges in certain developing markets can make it more difficult for us to be consistently competitive for assets in those regions.'

What are the most interesting opportunities for you at the moment?
Brandmeyer: ‘The demand for liquidity is growing. The largest constituency of sellers today is the larger financial institutions - commercial banks and insurance companies - on a worldwide scale. The range of their private equity investments has been very diverse, encompassing the whole spectrum of buy-outs and venture capital, mezzanine and distressed. Importantly, they are very sophisticated and often repeat-sellers. They are not in distress. They have medium to long-term asset management objectives in respect of their private equity portfolios. Many financial institutions are subject to capital adequacy and other important regulations, and the secondary market is helping them optimise their capital structure in an efficient way. They are very thoughtful and deliberate about the way in which they sell their assets.'

Kojima: ‘Broad auctions tend to be a less efficient way to achieve liquidity in the secondary market. Now, this is somewhat counter-intuitive. Unlike a typical buyer-seller dynamic, the secondary market sees the most crucial pieces of information held by third parties - the general partners - who are often reluctant to share sensitive and confidential portfolio company information with multiple secondary buyers. Auctions can therefore lead to a wider range of potential outcomes for sellers, given these informational and process challenges. In some cases, particularly in tough market conditions, buyers may trade information for price, and offer lower bids when the lack of information increases uncertainty. '

Is that a trend that you believe is likely to continue?
Brandmeyer: ‘Absolutely. We have seen the repeat-sellers observe this dynamic. They are focused on certainty of closing, on working with teams that have experience. And they are very much focused on confidentiality.'

What about the market for 'synthetic secondaries'?
Clark: ‘We continue to see opportunities in the portfolios of direct investments held by financial institutions and corporations. In other cases, we are seeing general partners with older portfolios look for liquidity alternatives in the secondary market - an exit strategy that compliments their strategic exits or IPOs. This part of the synthetic secondary market is only now developing, and we believe this is an emerging opportunity.'

What's your perspective on the competitive environment among secondaries players?
Kojima: ‘The competition has increased in the secondaries market. There have been new entrants into the market and large funds raised, but there remain some real barriers to entry. Sellers insist on confidentiality, creativity, certainty, and a track record of efficient execution. Buyers in this market need to respond to these needs with an experienced team, with significant resources, and with deep relationships with general partners.'

How much activity are you seeing in terms of distressed sellers?
Hope: ‘Some high net worth individuals are facing certain challenges, either needing immediate liquidity for cash management or having difficulty meeting future capital calls. But in terms of dollars and the global demand for liquidity, the market is primarily dominated by large financial institutions that are not in distress. They don't need to sell immediately for cash. They want to work with buyers that will spend time with them, that will work through the portfolio and make them feel comfortable that they will get a fair price.'

What is the biggest mistake you have made?
Clark: ‘We probably expected the gap between sellers' expectations and our valuations to narrow faster than it has. We thought it would happen throughout 2002, but it is only starting to emerge. As a result, capital deployment has been slower than we anticipated for the entire industry. In many respects, 2002 was a year of “price discovery” among sellers. They first explored the market to get a sense of what their portfolios were worth, and then ended up doing very few deals. We are starting to see transactions occur this year because that gap is narrowing. In some cases, there have been catalysts to make this happen, such as a mergers, restructurings, or new regulations coming into force in the US and Europe.'

How will the market develop in the future?
Kojima: ‘The secondary market has changed quite dramatically over recent years, not just in terms of size, but also in terms of sophistication. Short-term and longer-term factors are creating an increasing demand for liquidity from all types of private equity investors. Existing buyers are expanding their activities, and new entrants are emerging. Over time, we expect this increasing supply and demand will drive further innovation and create efficient mechanisms for liquidity. This will benefit all participants in the asset class.'

Clark: ‘In the near term, we will continue to see an increasing demand for liquidity among financial institutions. Over the long term, we believe further growth in the market will come from pension funds, endowments and foundations and other investors actively managing their portfolios. And as the secondary market gains greater liquidity, many institutions will address their fiduciary obligations to their beneficiaries by considering options in the secondary market, just as they would for their more liquid public equity or fixed income investments. They will start using the secondary market as a way of achieving their asset management objectives - that could be diversification between asset classes, within the asset class, consolidation of managers. They will see the secondary market as a real tool for liquidity. Over the longer term, this will be a good thing for the private equity market.'

Copyright © 2003 AltAssets