Back to the future.
Secondary private equity. Those who invested in secondary funds during the financial crisis ten years ago were able to generate high double-digit returns per annum. "Such a Second(ary) opportunity is now available again," Florian Dillinger, Matador Partners Group AG, is convinced.
"Do you remember the cult film 'Back to the Future'?" asks Florian Dillinger, founder and main shareholder of the Matador investment company, "the protagonists Marty McFly and Dr. Emmett L. Brown travel back in time several times with a time machine to correct events that would have had fatal consequences for their own future.
That's cinema, sure. In real life, this opportunity rarely exists. One of these opportunities is today.
"I can still remember 2009 very well. In the middle of the financial crisis, the private equity market was also in turmoil. Many investors had to sell and accept high discounts on the value of their investments. The buyers - mainly secondary funds - then generated 20 to 30 percent per anum in the following five to six years," says Dillinger. At that time, hardly any investors would have seized this opportunity. "Now the gold-digger era is coming back."
To understand this investment idea, investors need to immerse themselves a little in the exciting world of the private equity industry. "Private equity funds - the so-called primary funds - look back on six years of boom. In no other period have private equity managers raised more capital from their investors," explains Detlef Mackewicz, consultant at Matador. Fascinated by double-digit returns in the past upward cycle, more and more investors invested ever higher amounts in this segment. They also increasingly used the leverage of borrowed capital and entered into high future payment obligations with the funds.
They had in mind a kind of perpetual motion machine of earning money. Their funds, they planned, would regularly generate income through so-called exits - IPOs of the portfolio companies or their resale to other private equity funds. These earnings would flow to the investor. And the investor would not only be able to meet his payment obligations. They could also subscribe to new funds. Dignity. Could.
Now this machine is faltering. "In recent days, many private equity transactions have already been postponed or completely cancelled. Potential buyers are standing on the sidelines, waiting to see how the purchase prices and financing conditions develop," explains Dillinger.
Against this background, it can be assumed that some private investors are now likely to have difficulties in making the agreed capital commitments. "They will then have to negotiate with the fund managers to reduce their capital commitments or sell some of their private equity investments.
At the same time, large institutional investors - banks, insurance companies or pension funds - are confronted with a phenomenon that has almost been forgotten, the denominator effect. "In recent years, they have made full use of the permitted quota for private equity in their portfolios. As a result of the slump on the stock markets, their relative share is growing in comparison to other asset classes. This puts the target allocation out of balance, and institutional investors suddenly show an overweight of private equity," explains Mackewicz. "If prices on the securities markets do not recover dramatically, these investors will be forced to sell private equity funds by the end of the year in order to bring the quotas back into the framework permitted by the regulators - regardless of the price," Dillinger concludes.
The important thing is: In such stressful situations there are hardly any buyers within the network of PE funds. "Therefore, the hour of the secondary market funds has come. They are the only major buyers and will be able to negotiate high discounts on the value of the investments in the primary fund", Dillinger is convinced. He says there is already a foretaste of this. "At the turn of the year, the discounts were in the single-digit range. Now the indication is already 30 percent and more, although hardly any transactions are taking place. In the end, depending on the quality of the primary funds, we'll end up with 20 to 70 percent."
This spread is so wide because the economic future of the companies in the private equity funds is naturally uncertain. In an economic downturn, there is a great danger that valuations in the primary funds will be too optimistic. If they include a number of companies that could face the risk of insolvency, even a discount of 80 percent could still be too low.
The greatest risk here lies in debt. According to analyses by the investment house Bain & Co., the PE industry has used more and more debt capital in its transactions in recent years. Commonly used key figures such as debt in relation to earnings before interest, taxes, depreciation and amortisation are now at record levels and thus significantly higher than in 2007 - the boom year before the financial crisis. The question now will be how companies with the high debt burden will get through the inevitable deep recession. "The success of an investment therefore stands or falls with the ability of the secondary manager," Dillinger points out. The secondary manager must not only have extremely good contacts in the industry in order to get the best deals at the right time. Above all, he must be able to correctly assess the value of the investments in the primary fund. "This requires a high level of expertise. Different discounts are appropriate, depending on the financing, industry, country of origin or time of investment," says Dillinger.
"When selecting the funds to which Matador entrusts capital, it is now even more important than before to check whether the managers in question are pursuing a disciplined pricing strategy and whether, when selecting new funds, no compromises are made in terms of the quality of the companies and the purchase prices," explains Mackewicz.
Another important criterion in the selection of new secondary funds is not only manager qualification but also their investment status. "The best chances have funds that are just starting to invest or have only invested a small portion of the committed capital," the expert explains. "These young funds can make the most of the opportunities and will therefore be the big winners".
Matador is in an excellent position to benefit from this, he said. "We are currently only 40 percent invested. 20 percent is available for funds that have already been subscribed. They will call up capital in the next few weeks to invest in primary funds in the event of a discount. And with the remaining 40 percent, we will subscribe to more funds and increasingly look for direct secondary transactions. Our goal is to be fully invested by the end of 2021," explains Dillinger.
Matador has just added one of these potential winners to its portfolio with the secondary fund eQ PE SF III. "We have long preferred private equity funds that invest in smaller companies. In this segment, competition among investors is much less intense. The individual transactions are carried out on a moderate price basis and less debt capital is used," explains Mackewicz. There would also be greater potential for operational improvements. "In most cases, these companies are coming into contact with private equity for the first time, whereas companies that have already been owned by private equity companies on one or more occasions have largely exhausted their optimisation potential".
Because Dillinger and Mackewicz are striving for broad diversification of their investments, they have recently looked outside the American and classic European markets. "In the process, we became aware of the secondary specialists at the Finnish asset manager eQ Asset Management and then took a close look at it."
The eQ Group is a company listed on the Finnish stock exchange that focuses on asset management and corporate financing. In the third quarter of 2019, the Group's assets under management amounted to EUR 7.2 billion. "This makes eQ Asset Management one of the largest independent asset managers in Finland," says Mackewicz.
For their new secondary fund eQ PE SF III, the fund managers are aiming for a net target return of 14 to 17 percent - calculated on the capital invested by the investors. The fund management is planning to purchase shares in funds in which eQ is already invested. In this way, it intends to make use of the information advantage it has gained from its historical cooperation with the fund managers concerned.
"This is very interesting for us because it allows us to diversify our portfolio regionally", explains Florian Dillinger and concludes: "All managers of secondary funds will have an extremely lucrative window of opportunity for one or two years to buy private equity funds at low prices. If we then look back on this period in 2025, we will see that many private equity managers have brought their companies through this crisis well despite all the dangers. So for us investors, the rule is: If we don't buy now, when will we?"
Matador - buy when the guns thunder.
"We are very well positioned to benefit from the opportunities that will arise in the private equity market in the coming months," Florian Dillinger is convinced. Currently, 20 million of the balance sheet total of 50 million euros has been invested. "We restructured massively last year in areas that will hold up comparatively well in the coming economic crisis - infrastructure, medical technology, life science and IT. We also invested our liquidity very conservatively and sold riskier securities in good time. As a result, we are hardly affected by the market turbulence in this sector", explains Dillinger.
Of course, admits the professional, valuation changes in existing fund investments would probably put some strain on the portfolio in the future. "In the medium term, however, this should be clearly overcompensated by the new, now very, very promising investments of the funds. The funds can draw down eleven million from us for this purpose."
Dillinger intends to invest the remaining 20 million successively in newly launched secondary funds or one or the other direct transaction on the secondary market. "So, for us, this crisis comes at a favorable moment overall", the professional concludes.
This seems to be a similar view in the capital markets. After all, Matador's listed shares remained very stable during the turbulence of the past few weeks.
Dillinger would like to raise additional investment funds in the coming months through smaller capital increases. "The market environment is simply too good for us at present - we must not let this pass us by unused. An investor had already subscribed three million at the end of April. In the future, we will increasingly address other interested parties from the network."
The basics of private equity investment.
Anyone who subscribes to a private equity fund initially only makes a capital commitment. If the fund managers find an interesting investment target, a capital call is made and the investors have to pay in. "Firstly, it is therefore important to limit the amount of one's own commitment so that the capital calls can be paid for with certainty," Detlef Mackewicz makes clear.
Secondly, investors should not only diversify widely across sectors and regions, but also across investment years. "It usually takes four years before a PE fund is fully invested. So timing doesn't make sense. Nobody knows how the economy will develop over the next four years," the professional explains. Because prices are falling fü̈r Firmenkä̈ufe in times of crisis, private equity funds, of course, which take up investment activity in economically difficult times, often achieve very satisfactory results. "Thirdly, it is therefore important to build up a private equity program for the long term. Then the differences in performance of the individual Jahrgä̈nge tend to even out."
Investment in secondary private equity funds is a kind of shortcut on the way to building a private equity portfolio. This is because their managers specialise in buying already existing private equity funds at the greatest possible discount to the net asset value of the investments. "Investors can thus access a diversified portfolio of funds of different vintages, regions and styles at low cost and immediately", explains Florian Dillinger.
Since this market is only open to very wealthy private investors, given the minimum investment amounts of several million euros, Dillinger founded the Matador investment company. The share (ICH0042797206) is listed on the stock exchanges in Bern and Frankfurt. Through this vehicle, a broadly diversified secondary private equity portfolio with no minimum investment restrictions is now available to all interested investors. "We currently hold investments in 15 private equity funds with a total of 1100 companies and will now significantly expand our portfolio during the economic crisis," concludes Florian Dillinger.
Matador Partners Group AG
Ground roof 5; CH 5-6060 Sarnen
41 (41) 662 10 62