The keys to success in GP-led secondaries deals

Adam Le: Welcome to Nexus 2024. My name is Adam Le. I'm a senior editor at Private Equity International. And with me here today is Paul Sanabria, Global Co-Head of Secondaries at Manulife Investment Management. Paul, thanks for being here today.

Paul Sanabria: Yeah, good to be here with you today, Adam.

Adam Le: Great. Paul, I'm just going to ask you sort of three really quick flash questions about the GP-led market because you invest in GP-led deals. You invest in continuation fund deals. So, you have a good sense of kind of what makes for a good deal, what makes for a kind of less attractive deal. So, for you as an investor, you know, in your experience and you've been on the buy side and advisory side as well, what are the good key ingredients for a successful GP-led secondaries deal?

Paul Sanabria: Sure. So what I would say, Adam is like investing is really pattern recognition. So, what you want to do is create a framework, and our framework is fairly straightforward. And the devil's in the details, but it's about assets, sponsor, alignment and what we call secondary deal dynamics. So, real quick, I mean asset, do you like the asset? All the bottoms-up analysis that you would do in terms of market strategy, value creation plan, etc. That's very important and we do that bottoms-up analysis and then at the end, we put a point on it with valuation, which is almost like a scorecard as to whether you're going to do the deal or not, from a math perspective. We look at the sponsor and there’s all the elements you would expect in terms of performance, but probably the most important one is around motivation. Is the motivation the right motivation? So, we look at that very carefully.

Adam Le: How do you, how do you identify motivation? That’s quite, that can be quite a kind of difficult thing to put your finger on sometimes.

Paul Sanabria: It is. But again, pattern recognition is important. You know, we see roughly four investment opportunities a week. We’ve seen over 750 investment opportunities in the last four years alone.

Adam Le: Wow.

Paul Sanabria: So, imagine when you see that coming in every day, you start to notice patterns related to, and specific to your question, motivation, right? Is this being driven for the right reasons? I mean ultimately GP-leds, if you go back to the beginning of time, it was really all about—beginning of time in terms of modern-day GP-leds, which is roughly 10 years old—it's really about, you know, am I the best owner of this asset going forward? And if I am the best owner of this asset going forward, am I willing to put my money where my mouth is? Am I willing to put an enormous amount of capital, which gets to that third point of alignment, right? Which is about when will I take my crystallized carry and put it into the deal? Will I take my GP-commitment profits and put it in the deal, and then will I personally write a new cheque and or will the flagship fund put in money? If you’re willing to say I am the best owner of that asset and I’m willing to do what I just described, that's pretty good motivation. If it’s I'm doing this for fundraising… red flag, right? If I’m doing this in a multi-asset deal and I'm trying to stuff in a bad asset… red flag. So, those are the types of things that I think over time you just become, you know, experienced in recognizing.

Adam Le: And do you sort of have a checklist where, you know, when you look at a potential deal, you know, checking for motivation, you know, fundraising, that kind of thing? Or is it a bit more sort of on the human side? You don’t actually need to get out and meet the GP, even meet with the portfolio companies, for example.

Paul Sanabria: Look, it’s both. You do need to meet with the sponsor. You do need to meet often with the management team in these deals, but you also have to have a discipline process. So, there is an element of a checklist around the asset, around sponsor, around alignment. And we haven’t got to the fourth one, which is really that secondary deal dynamics, which we can talk about. And yes, I mean, our deal teams specifically are focused on those four categories, and really drilling deep into making sure that we understand them. Because you know an investment decision, I said “put a point on it” in regards to valuation, it’s actually not just about valuation, right? A bad opportunity is not because all the elements don’t line up. It could simply be it’s overpriced. So, it would be a great investment to be in if in fact we were able to turn back the multiple one or two times and then everything else aligns. So, there's a little bit of art and science to investing, as you know. Somewhat of a checklist in nature, and then somewhat of an art in terms of how you get information, and how you think about, particularly in secondary deal dynamics, how you think about some of the aspects, the softer elements. Things like is there really a pricing arbitrage here? What do I mean by that? It could be sort of a transformative M&A that is pending. You have the ability to be able to really get behind that and understand is that really going to happen or not? Now those are really important elements. Is the sponsor trying to force a timeframe that isn’t appropriate? Is the sponsor not giving you all the information that you need? Is your platform providing you information that perhaps other people don't have? We sit on a very large, what we call sponsor-centric platform, where we have a primary business, junior capital and direct lending. There's tremendous information flow and sometimes we have better information. Those are some of the sort of secondary deal dynamics that we look at also that are a little softer.

Adam Le: You mentioned that you've looked at you know over 750 deals over the past few years. What have been, you know, if you could add any advice of two or three key sort of red flags for the deals that you haven't invested in, for the deals that you've passed on.

Paul Sanabria: Sure. Look, we are very conviction-oriented. So, we tend to have more of a concentrated focus. So, we tack towards single-asset continuation vehicles or fairly concentrated multi-asset vehicles, typically three assets or less where you tend to see stove pipes like a single asset dominating or a couple. So, we have the ability to peer very closely at individual assets. That's what our goal is. We have a philosophy, which is to underwrite concentration at the investment level and manage risk at the portfolio level. That's where you take advantage of diversification. So, with that as a backdrop, look, the easy transactions to quickly pass on are those transactions with bad motivations or with the wrong asset and that's really where we spend a lot of time. And it quickly gets to alignment, that's a quick checklist item you can look at and see, you know, is there sufficient capital across those elements that I described? That's a very easy one to look at. A good example: the first deal we did, the investor put, excuse me, the sponsor put 300 million of their flagship fund in, 50 million of rolled carry and rolled GP commit. 350 million, it’s actually a euro deal of a $2-billion deal was the sponsor.

Adam Le: Wow.

Paul Sanabria: That's very good alignment, right? What we're really looking for is franchise risk and personal wealth risk. So, those are sort of some of the easy ones. And the asset, oftentimes it comes down to bottoms-up analysis. So, you might not believe fundamentally in the growth story or there could be regulatory risk, something of that nature. But oftentimes it comes down to valuation, which is something is just overpriced from our perspective and/or it just doesn't drive to the return that we expect. You know, unlike the LP market where it's about doing the math and it's very desktop-oriented. You look at cash flow curves, try to add a little bit of your secret sauce where you have better information than anybody else, and essentially out pops a return. The return doesn't work for you and so you put in a discount. I grossly oversimplify the LP secondary market, but broadly speaking. In our market, it's not quite that, right? You're underwriting deep concentration, you're looking at these assets very deeply and you're coming up with a price, this is what I'm willing to pay. And in today's environment where there's a lot of volatility in that, sometimes the math just doesn't work for us to drive to the kind of return that we need. And candidly, there's only so much wiggle room in terms of what a sponsor is willing to take in terms of price capitulation in this market.

Adam Le: OK. And thinking forward about the growth of the GP-led market, you know, secondaries market today, roughly $115 billion market, GP-leds account for roughly half of that. Roughly even split between single assets and multi assets. What's your prediction for the growth of this market in five to ten years time and are there any things that could scupper that growth?

Paul Sanabria: Look, our market has grown, has doubled each five years in transaction volume. If you look at five-year clips, over the course of the last five-year clips, it's doubled in size over that five-year period. And we don't see anything that is going to stop that, both in the broader market, and the GP market actually may accelerate a little bit faster. And so what's the justification for that? First of all, let's remember that the transaction volume in the secondary market is still a relatively small fraction of the existing assets that exist within the broader, private-market marketplace. Liquidity is a core function of any organized market. As we expand, the total volume of that as the volume of commitments in funds goes up, as we bring in adjacencies with infrastructure and real estate and the big one that's coming, private credit, that all suggests that there's going to be sort of an expansionist market. So, we really believe it's going to grow. And in GP-leds, you know our view, Adam, is we're very bullish. The biggest issue right now in GP-leds of course is capital constraints. There's simply not enough capital in this market right now to address those four deals that we see every week. I'm confident that that's going to be solved. There's a variety of capital sources that are coming online and I think will actually solve that particular equation. But if again, you go back to the core of what I said, which is if the prime motivation is I am the best owner of that asset and I'm willing to put a lot of money into that, then you view that as a fourth option from an exit perspective, which sponsors do today, then the market is only going to continue to go up and to the right.

Adam Le: And can I press you on a numerical figure?

Paul Sanabria: For next year or five years?

Adam Le: Let's say five years.

Paul Sanabria: Look, I think five years, the overall market? Look, the overall market transaction volume of the market, four or five hundred billion…

Adam Le: OK

Paul Sanabria: In five years.

Adam Le: So half a trillion.

Paul Sanabria: Yeah, I don't think that's an unreasonable amount if you think about the doubling of the market. Maybe three to four, I would say three to four hundred is probably my bid ask for that.

Adam Le: OK. Fantastic.

Paul Sanabria: Yeah.

Adam Le: Excellent. Well, thank you very much for your time, Paul Sanabria, Global Co-Head of Secondaries at Manulife Investment Management.

Paul Sanabria: Great. Good to be with you, Adam. Thank you.

Adam Le: Thank you.