Dialogue: Matthew Arkinstall

London-based Greenpark Capital is preparing for what some believe will be as much as $36.5 billion in closeable secondaries deal flow this year. Matthew Arkinstall talks to PE Manager about some of the valuation issues the secondaries firm faces today.

WHAT IS THE BIGGEST CHALLENGE TO SECONDARY INVESTORS IN TERMS OF VALUATIONS?
Valuation is always a challenge, and at the time of purchase at Greenpark we do it company by company, by looking at the business model, financials and capital structure of each company in a secondary portfolio. Two particular challenges at the moment we would say are balance sheet issues, in particular taking a view on the term, re-financeability, and covenant-headroom on debt in portfolio companies; and the robustness of GPs themselves. Some GPs won't survive the downturn, and those that don't will leave orphan portfolios that are not being managed for maximum value and earlier exit. Also, GPs that are worried about not raising a next fund may not be too keen to exit their underlying companies, which may result in less attractive, much longer holding periods. We handle both issues very conservatively, by rejecting situations where there is risk that that we cannot price. We stay in our space – we invest in mid-market opportunities, in Europe, in relatively mature, largely funded commitments, in the buyout space. In this space, we can diligence companies, and GPs, to the extent we need to be able to form a view on future exits and exit values.

ARE THERE DIFFERENCES IN THE WAY US FUNDS MIGHT BE VALUED VERSUS EUROPE?
The European GPs, who have long experience using the EVCA guidelines, seem to be more comfortable with using multiples, while US GPs seem to be more comfortable with using DCF. In the latter case this can result in smoothed valuations, compared to earnings multiple approaches, which tend to be rather more uncompromising in writing assets down in value. However, with regard to the way we value companies for our due diligence, we adhere to the same methodology for US and European companies, but might use different assumptions on growth, profitability, and exit, depending on the industry, economic exposure, and future prospects of the company in its market.

WHAT IS YOUR PREFERRED VALUATION METHOD? DO YOU ASK GPs WITH WHOM YOU INVEST TO USE THIS METHOD?
GPs value according to the accounting standards and valuation practices that bind them – as one of many LPs we are not in a position to change this, nor would we want to do so. We realise that sometimes it is somewhat optimistic, sometimes it is somewhat pessimistic; with hundreds of companies populating our funds' portfolios the average value movements tend to be acceptable. For our own transaction purposes, in deciding on a reasonable price for a secondary interest, we tend to value each company using qualitative factors as well as quantitative ones, including an EBITDA multiple to determine overall enterprise value. We cross-check this with other methods, particularly in businesses and industries where other methods prevail or where use of an EBITDA multiple would be misleading. The price we are prepared to pay is unrelated to the book value of the holding although the book value does of course play a role in the deal structuring and negotiations with the seller.

DO YOU EVER DISAGREE WITH VALUATIONS GPs HAVE GIVEN YOU?
At the time of purchase, yes, particularly at the moment, where we are pricing using current multiples, and some GPs appear to be using smoothed, average historical comparables or discounted cash flow analyses. However, valuation is part art, part science, so there is room for reasonable people to either agree or disagree. What is more important, however, is the overall conservatism in the valuation process when making purchase decisions. However, after acquisition, we adhere to the accepted practice of reporting GP valuations, unless circumstances dictate otherwise. This is generally accepted practice not only in the secondaries space, but across the board, with other LP investors who must report values for their portfolios.

IS IT POSSIBLE YOU WOULD CARRY TWO SEPARATE VALUATIONS FOR THE SAME FUND – ie IF YOU PURCHASED POSITIONS AT DIFFERENT TIMES, WHEN ITS NAV PRICE WAS DIFFERENT?
No. We generally take the lead of the GP in its valuation process, and this applies across multiple holdings we might have in the same fund, irrespective of when we invested and at what price. We use the GP updated reported value at quarter end for all holdings in the fund, it is only the cost basis per holding that would be different.