The Write-Ups Are Real

A new annual report indicates that private equity performance is up based on real-deal, cash-on-the-barrelhead factors.

It’s been easy to voice skepticism about private equity valuations. After all, investments in this market are measured primarily by the fund managers themselves, who assign values to their own illiquid portfolio positions using methodologies that can be described, at best, as flexible and, at worst, as prone to manipulation.

I, for one, have filled many column inches with precisely this kind of skepticism.

Well, shut my mouth – the latest figures from publicly traded fund of funds Conversus Capital show that private equity valuations rose remarkably in 2010 and based largely on irrefutable realized gains and supremely verifiable public-market gains. These gains leave little wiggle room for GP imagineering, even if one were to be so cynical as to pursue this charge.

Conversus is a firm with roughly $2.6 billion in private equity fund assets that is listed on the Euronext Amsterdam, although its operations are based in the US. It was formed upon the 2007 purchase of a Bank of America private equity fund portfolio. As a publicly traded alternative investment manager, its regular disclosures provide an interesting view into the state of the market, and usually ahead of other market indicators. The firm’s 207 fund investments are a good proxy for private equity generally, representing a mix of mid-life and very mature funds and many of the largest fund-family managers.

Conversus’ latest communication comes in the form of its year-end 2010 financial results, released March 31. These should be of interest to anyone who is seeking to understand better what happened in private equity last year. We all know things continued to get better, but how much better, and in what ways?

At first glance, it is obvious that 2010 provided even more reasons to celebrate than did 2009. Conversus ended 2010 with gains of $308 million, versus being up $244 million in 2009 (these figures do not take into account investment income and expenses). But wait there’s more – Conversus’ performance in 2010 more tangible than in 2009, you might say. Of the $308 million in gains last year, fully $110 was from net realized gains, in other words, proceeds from exits like portfolio company sales and stock liquidations. Cash on the LP’s barrelhead. Compare this to 2009, when the GPs in the Conversus portfolio showed unrealized gains of a whopping $240 million but realized gains of only $4 million.

Clearly most of the GP mark-ups in 2009 were for good reasons – about 65 percent of unrealized gains were related to public securities, where the value is based on the stock price and not subject to further interpretation. But some of the write-ups from 2009 had to be brought closer to earth in 2010. Conversus reports that in 2010 “the $92.3 million in private net unrealized gains was net of $71.5 million in reversals of previous net unrealized gains that were realized during the year” (emphasis mine).

Giving further authority to the recent strong performance, the majority of unrealized gains in 2010 could not have been subject to GP guesstimation. Conversus reports that 57 percent of its unrealized gains were from public securities, mostly shares in private equity backed companies that have been taken public as a half-step toward total exit. Like many large limited partners, Conversus has indirect holdings in now-traded corporations such as Sally Beauty, Dollar General, Legrand and Rexel.

GPs appeared to be more willing – or forced – to spill bad news in 2010 than in 2009. Last year, Conversus had realized portfolio losses and write-offs totaling $126 million, while realized losses and write-offs in 2009 were $70 million.

Lest anyone think that private equity has merely been the beneficiary of rising public markets, Conversus’ portfolio outperformed the public markets by a meaningful margin last year. By way of comparison, the S&P 500 gained 15 percent in 2010, while Conversus’ net asset value gained 17.9 percent over the same period. Conversus’ uptick in distributions is just the beginning. It is likely that 2011 will be a humongous year for realized gains in private equity, given the matching pent-up demands for exits, corporate acquisitions and IPOs. Added up, it’ll be enough to make this asset class look pretty damn good again. Fundraising will still seem like a hard slog through a dark tunnel, but at least the light at the end will appear to glow brighter.