The data advantage in secondaries (Part 1 of 2): Sourcing deals

We spoke with Wilfred Small, Co-Head of US Secondaries & Primaries, Senior Managing Director & member of the ASF Management Committee, and Arnaud Mercier, Managing Director, to find out how data science and AI are supporting the team's approach. 

QUESTION 1.

Ardian's Secondaries & Primaries database covers over 1,600 funds, 650 GPs, and 10,000 underlying companies. How can we put those numbers in perspective?  

WILFRED SMALL

 - The dollar amounts associated with that portfolio are the largest in the industry for secondaries. Our combined Secondaries & Primaries platform is worth over $100 billion, and so as it relates to our dollar volume participation in the market, we are the largest.  

While there may be other groups with a higher number of funds, our model is to build concentration around GPs and assets where we have very high levels of conviction. That means we have a really deep, direct private equity-like approach to underwriting and monitoring the underlying companies we're buying. The nature of our strategy is far more diversified than traditional direct private equity, so you have to be smart in how you spend time, but I think we're unrivaled in the market as it relates to the depth we bring to our portfolio.

Broadly, there are two ways that you can approach underwriting in secondaries. You can do it from the top down, with a statistical approach to aggregate data and assign cashflow curves and multiples on upside. We do the opposite: we go from the bottom up, with an LBO analysis on each of the underlying companies in our portfolio. In so doing, we're forming a high-level view as to what we want to pay for a portfolio. We think this leads to differentiated levels of conviction and lower associated levels of risk because we have a very good understanding of the assets, typically being an investor in up to 90% of what we're buying. We do this each quarter as a business practice to create a constant state of due diligence, to better understand risk, and to move quickly on new opportunities.  

ARNAUD MERCIER

 - Making cash flow projections about what the companies that we acquire today will become in three, four or five years – that takes most of the team's time. You need to sit with GPs, discuss their business plan, how they will get there, and so on. Building bottom-up cashflow projections for thousands of private companies on a quarterly basis - which include a deep involvement of the team and not a statistical approach – I trust there is no other firm on the market doing that.  

QUESTION 2.

Where does the data come from?

WILFRED SMALL - If you're an investor in a fund, you get access to the quarterly report with data on the portfolio. But that's only 25% of the battle. The part that's really differentiated is getting a personal interaction with the GPs each quarter where they give us data at the company level with a degree of granularity as it relates to forecast, business plan, exit expectation and timing. And they're willing to do that with us because we're very large investors, both through our secondary business and our dedicated primary fund investing business that we call Ardian Customized Solutions, and because they know that we're in the business of long-term relationship building. And going back to the earlier point, while we may not have the largest number of relationships in private equity, we certainly have the largest number of quality relationships in private equity.  

ARNAUD MERCIER - Since AI tools made a lot of progress recently, the heavy lifting on the gathering of quarterly data and main KPIs from the GPs’ reports is now automated - but will still require for our GPs’ team coverage validation to be used into our systems – as we still see some inconsistency and inaccuracy depending on quality of the reporting. Also, we trust having the same team doing both Secondaries and Primaries investment is synergistic: our primary expertise helps us evaluate new funds, while when we look at secondary deals coming to the table, we have the full history of how those funds have been performing and which assets should be generating upside or downside. In many cases, we are also a LPAC member which can give us additional information or context about how portfolios have behaved. Some peers will only do their due diligence at the moment of a secondary transaction, and so they just get a snapshot of what's happening at that time. But because we've tracked the historical evolution, it's like watching a photo and a movie – it's a completely different approach. Also, as we discuss assumptions with GPs every quarter, they tend to be more transparent and accurate because they know we'll be back again with the same questions in three months’ time. 

WILFRED SMALL - What becomes really powerful is the cross-referencing of data from the different GPs with whom we invest. In many cases, they're invested in the same or comparable companies. The database leads to insights that we're able to develop with the help, in some cases, of artificial intelligence. We're also able to develop our own benchmarks by nature of having access to this private information at a large scale.  

QUESTION 3.

What are the advantages of this approach for deals?

ARNAUD MERCIER - Having conviction on the assets is really key. We buy assets that we know are good quality and that we've been tracking for a while. We aim to create value from the appreciation of the funds over time, not so much with the discount at entry. Having an existing and deep knowledge of the funds we wish to buy is a real differentiating factor, particularly in a market environment where Sellers are welcoming cherry picking of funds to match their expectations and wishing to transact quickly.  

While only a handful of players can compete with us on the large end of the market, where deals are increasingly $2-billion-plus in size, speed and reliability of execution matter. We've won deals by providing indicative or firm pricing before the data room was even set up because we already had full portfolio coverage through our Database. We were able to press the button before others even started their due diligence. Thanks to our conviction on assets, we are also known as a trusted counter party who will deliver on the terms we have promised, sometimes despite negative macro challenges coming up. Combining together one of the largest team in the industry with systematic monitoring and pricing of funds’ flow names, we are really one of the only few who can reliably deliver on pricing and closing a large-scale portfolio in under a couple of months. 

WILFRED SMALL - The other thing that is really unique is that the database and constant state of due diligence enable us to be proactive and create secondary and GP-led deals that weren't on the market. We develop a 'buy list' of specific funds or companies within funds that we want to buy. And we make it our job to go to sellers or the GPs directly and say, 'Have you thought about this continuation fund idea?' in the case of a GP-led transaction, or 'Have you thought about monetizing this book of funds within your portfolio?' That's differentiated because it's not waiting for the market to come to you, it's you going to the market and making something out of nothing.  

ARNAUD MERCIER - With the development of GP-led multi-asset deals, we have adapted our tools to source proactively more opportunities. Every quarter, we extract all the top-performing underlying assets and companies across our private equity portfolio – for example, assets invested over the past four or five years, growing 20% EBITDA CAGR (compound annual growth rate), with further growth expected – which gives us a shortlist of companies that could be attractive for a multi-asset deal. This allows us to initiate discussions with GPs. And even if ultimately an intermediary is appointed to run the process, being ahead of the curve in terms of knowledge and conviction already creates a differentiated angle.  

Inside IBIP: Ardian’s proprietary database for Secondaries

Source: Ardian proprietary database for performance since exposure, and GainPro or public comparables provided by the GP for market data.

(1) CAGR since the beginning of exposure vs. market CAGR for the 2017-2022.

(2) Margin as of Transaction RD vs. market margin as of the last reported period.

(3) At Ardian entry, based on the simple average EBITDAx of the top 5 assets vs. comparable peers.