Private equity valuations: Are we overvalued? With Michael Weinberg, Tokyo University of Science Endowment

In today's financial landscape, the debate over whether private market valuations are over or undervalued is increasingly urgent. With private equity markets showing a bias toward overvaluation—evidenced by low distributions and seller expectations outpacing buyer interest—the stakes are high. With SuperReturn North America around the corner, Michael Oliver Weinberg, Special Advisor, Tokyo University of Science Endowment, explores how these economic shifts affect mergers and acquisitions (M&A), initial public offerings (IPOs), and investor strategies, providing insights to help navigate the complexities of inflated asset prices and transparency demands.

Are current private market valuations over or undervaluing the assets?

In aggregate, private market valuations continue to be biased toward overvaluation. This is one of the many reasons distributions from PE funds have recently been near 25-year lows, at approximately 12%, half of their 25-year average of 25%.

Based on our extensive conversations in the US and Europe a week or so ago with PE firms and company management, sellers are, on average, 10-15% above the market, or where buyers would be willing to transact.

Splitting the spread, this implies that, on average, PE is likely marked 5-7.5% above where it should be.

That said, the best companies are trading or selling at full, if not premium, valuations. It’s the middle-of-the-road companies and less attractive companies that aren’t trading.

What, if any, impact did the Fed’s tightening cycle, and now the Fed’s most recent rate cut, have on M&A, IPOs, and asset valuation in 2025?

Until last week, when the Fed cut rates by 50 basis points, with SOFR previously at 5.25%, the economics of private equity were far less compelling than when SOFR was 5% lower a few years ago, pre-Fed rate hikes. Higher rates put a material damper on M&A, at least partially due to the increased cost of leverage, commensurate depletion of cash flow, lower net returns, and diminished net present values.

That said, now, post this Fed rate cut, with many more cuts expected by the market, there would be multiple benefits for PE firms and companies, including a lower cost of finance, higher profits, and more cash flow to pay interest, debt, and dividends, leading to higher net present values. Particularly if rates decline more, as the market expects, this could, in turn, catalyse the animal spirits, including M&A and even the moribund IPO market.

Should investors brace for markdowns or markups?

Though perhaps a red herring, in Japan of all places, where the IPO market has been dormant for some time, there are now two potentially on the block. As to whether they proceed and whether this presages a further bull market in Japan or globally, or a top in IPOs and their market, that is yet to be determined.

In any case, the better the M&A and IPO markets, the better for PE, distributions, and investors. We wouldn’t be surprised if we are now past the trough valuation of private companies, and though the timing is uncertain, we may start seeing a recovery in all of this – IPOs, M&A, private market valuations, and distributions. That would, of course, bode for markups in aggregate rather than markdowns.

With your background as both an allocator and manager, how do you manage LP pressure for valuation transparency?

That’s easy. Valuation models, assumptions, and philosophy should be consistent, objective, auditable, understandable, and logical. Importantly, all of this should be shared by GPs with LPs. There is no reason not to.

It’s like the old cliché relating to Warren Buffet, with whom we once made a million-dollar bet for charity. Anyone can be given a bat, but not everyone will be a great hitter. Valuation transparency is akin to the bat. If not commoditised, its low value-add should be shared liberally.

What should investors focus on when dealing with inflated asset prices in private equity?

For funds investors are already invested in, there isn’t anything that they can do unless they want to transact in the LP-led secondary market or if they are offered a GP-led transaction. Though, ceteris paribus, they should be aware that if the M&A and IPO markets don’t open up, the marks are likely overstated by, on average, the 5-7.5% we alluded to earlier. That said, if the markets do open up as we expect them to, this spread should narrow, and valuations should catch up with marks, which, in light of the historic documented lag in private markets, would not be surprising.

Are the valuations of secondaries compelling on an alpha or beta basis?

On a beta basis, the short answer is no. And on an alpha basis, the short answer is yes. Though, in aggregate, spreads have narrowed materially over the past 1-1.5 years, there is still significantly more supply of secondaries than demand. The attractive supply/demand imbalance has at least partially been bridged by the record asset raising by secondary funds, which now, for the first time, can be in excess of $20 billion AUM. This is driven by both institutional and private wealth channels.

Why are LP-led secondaries attractive on an alpha basis?

That said, though we would not want to put massive amounts of capital to work in the space, i.e., on a beta basis, due to the record interest, demand, and investment, there are compelling opportunities on a more selective or alpha basis. There are still plenty of forced sellers, both institutional and private wealth. They have often over-committed to privates, haven’t had the distributions they had modelled or experienced over the prior quarter-century, as we mentioned previously, and therefore have no choice but to seek liquidity in the secondary market. We’ve written papers, including one published by Institutional Investor, as to why secondaries are compelling, so we will refer readers to those instead of going into the detail here.

Why are GP-led secondary valuations as or more compelling on an alpha basis?

GP-led secondaries are potentially interesting as 80-90% are not re-upped by existing investors for various structural reasons, including time constraints on re-upping or an inability to go back to an investment committee.

At the same time, 80-90% of GPs do re-up or roll their interest into these secondary strategies. As an investor, one would be inclined to be aligned with the GP, which would bode well for investing in these GP-led secondaries on average, though again, we would be more alpha-based. Though there is a material tailwind, as these are often the highest quality, best assets, and the GP may often have superior, asymmetric information compared to the LP. Consequently, the valuations of these are likely to be quite compelling for secondary buyers.