Fair Value, DaRC Transparency

A recent article from the Private Equity Manager’s Daily Digest titled “When is fair value not fair value?” provides interesting and sharable comments about the decision taken by the American Institute of CPAs (AICPA) to create a task force and deliver more granular rules for “valuing hard-to-price non-quoted companies”.

The conclusion of the article, envisaging that GPs may end up running two valuation books, one to respect auditors’ rules and the other to explain valuations to investors, implies that we are not asking the right question.

On the one hand, investors and regulators seem to have concerns that go beyond valuation rules and that even the two parallel books may not address.

GPs are facing challenges that are about regaining investors’ confidence, dissipating the skepticism that industry surveys continue to record.

On the other hand, stakeholders do not seem to properly use all the already available information and rationally reconsider the substantiality of their concerns.

If stakeholders keep benchmarking private capital returns using flawed methodologies, they keep producing marketing messages but obtain no factual evidence and forward-looking reassurance about the risk-reward profile of private capital investments.

Private funds have rules that allow GPs to discretionarily decide, within LPA’s contractual boundaries, the timing for divesting portfolio assets. There is a “theoretical possibility” that a certain asset, potentially purchased at high multiples, as it continues to perform well in terms of EBITDA growth, is “fairly repriced-up” even if general market conditions, at the moment of the interim valuation, would not seemingly grant an exit at the same levels of the entry multiple. The GP may justify this view for example with the existence of strategic buyers that will pay at least the NAV price. This is not unheard of, is it?

“Res tantum valet quantum vendi potest”. There’s no need to argue.

Stakeholders could instead review the available fair value data, taking into consideration the different calculation possibilities allowed by the existing IPEV rules:

  1. to understand the valuation style of the GP being analysed and verify its ability to deliver the promise of future value embedded in the progressively delivered NAV information;
  2. to put it in relation to the purposes of the fair value being analysed.

Two different examples show that, if value is consistently delivered (point 1 above) after being promised, “how fair” depends on stakeholders’ perception (point 2 above) vis-à-vis the purpose of their analyses:

  1. I recently read somewhere (I will find and link that paragraph sooner or later) the n-th eulogy of the benefits of not marking to market illiquid assets that testifies about a persistent allergy to market volatility, in particular, among long term investors. It should be clear that I see the point but disagree (ultimately for reasons of substance over form – but there is room for a “fair debate”). Still, assuming that point 1 is true, per point 2 fair value is fair even if not marked to market.
  2. If fair value is investigated in relation to liquidity the purpose is instead the assessment of value vis-à-vis market conditions – volatility, risk premium, pricing levels, etc.

In previous posts, I talked about the fact that GPs seem to know better the value of their portfolio assets and yet they find it hard to correctly predict the timing of the exit at their targeted valuations. But I also suggested that there is a “DaRC way” for stakeholders to obtain valuation transparency and get to know where they stand:

  1. Analyse NAV-derived time weighted returns versus market levels, adequately plotted on a coherent time scale;Immagine1
  2. Test forward-looking duration sensitivity and gauge the S-curve versus market and portfolio expectations.

Past (unrealized) private capital performance can often be indicative of future returns…

 

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