A tale of two funds at Bain Capital

Bain Capital Fund IX

Vintage: 2006

Size: $8 billion, with a $2 billion co-invest fund

Bain Capital Fund X

Vintage: 2007

Size: $10.7 billion, with a $2 billion co-invest fund

Limited partners in Bain Capital funds: Alaska Permanent Fund ; California State Teachers’ Retirement System; Pennsylvania State Employees’ Retirement System

By the first quarter of 2009 Boston-based Bain Capital, renowned for bringing a consulting mentality to the task of improving portfolio companies, had marked down its Fund IX portfolio to 60 percent of the cost of the underlying investments, according to an investor presentation for Fund XI that was reviewed by Buyouts. It had to have been a humbling moment for a firm with a history of producing gaudy, double-digit net IRRs since its founding in 1984.

To its credit, Bain Capital took full responsibility. It admitted to “ignoring the element of time diversification,” according to a source familiar with the firm, and to buying “highly cyclical” businesses at exactly the wrong time. But thanks in part to the economic recovery, and to its having bought some fundamentally solid companies, Bain Capital has gradually brought the valuation back.

Probably the capstone to the 2006 fund was the hospital operator HCA, the second-largest LBO ever, in which Bain Capital teamed up with Kohlberg Kravis Roberts & Co and Merrill Lynch Global Private Equity to take company private in a $33 billion deal. HCA went public again in March 2011, and its shares have risen 50 percent since then. The investor group still owns nearly 40 percent of the company.

Another portfolio company, home repair supplier HD Supply Holdings, was at one point considered to be a wipeout; former parent Home Depot, which retained a stake, was reported by the Atlanta Journal Constitution to have written the investment down to zero in the wake of the housing market’s collapse in 2009. Today the company has filed for an IPO likely to raise as much as $1.33 billion, sister website peHUB reported in July.

Bain Capital appears to have scored two additional Fund IX exits in the fourth quarter. In October, Burlington Stores went public after a seven year hold; peHUB calculated that the firm’s return would be 4.25 based on the stock’s price after its first day of trading. In November, Bain Capital agreed to sell Applied Systems Inc., a maker of software for insurance companies, to Hellman & Friedman LLC in a transaction valued at $1.8 billion; a person with knowledge of the situation said Bain Capital could see more than a 4x return on its invested capital there as well.

Overall, the investment multiple on Fund IX now comes in at 1.8x and is projected to reach 2.3x, according to an investor presentation that was reviewed by Buyouts. (Between the sale of Applied Systems and another recent mark-up the investment multiple is up to 2.0x, according to a source familiar with the firm.) The net IRR stands at a respectable 7.6 percent. And while Fund IX is likely to be among the weaker performers in the firm’s history, it is still expected to deliver at least 400 basis points of excess returns when compared to a benchmark such as the Standard & Poor’s 500-stock index.

Backer Regents of the University of California put the return multiple for Fund IX at 1.5 and the IRR at 7.4 percent as of March 31. According to the Buyouts performance database, that would place the 2006 fund close to the top quartile by fund multiple, and close to the median by IRR. The 2006 vintage class, among the weakest in the database, recorded as of year-end a bottom-quartile multiple of 1.2x, median of 1.3x and top quartile of 1.5x, while the corresponding were 3.1 percent, 7.5 percent and 11.7 percent.

The Successor

The story of the $10.7 billion successor fund, vintage 2007, has been a more complicated one for Bain Capital to tell.

The firm had invested $2.2 billion out of that fund before the collapse of Lehman Brothers in September 2008 threw the economy into full-blown crisis. As a result, the 2007 fund has the hallmarks of a much younger fund, as Bain Capital largely shut down domestic deal-making for more than a year in 2009, returning to activity only after the economy began to recover in 2010. As recently as September, Bain Capital was adding to the Fund X portfolio, with the take-private of BMC Software for $6.9 billion, a deal that it led with Golden Gate Capital.

In talking with prospective investors in Fund XI, Bain Capital divides the Fund X portfolio into pre-crisis and post-crisis buckets, with the post-crisis bucket further divided into value, growth and emerging markets investments, according to the investor presentation.

The firm has had its challenges with the fund. That Bain Capital invested the pool relatively slowly meant that management fees drawn down from investors created a major drag on the IRR in the early years. In addition, the firm found its best opportunities in the wake of the financial crisis to be in deals requiring equity checks of $250 million to $300 million, rather than the $500 million to $600 million that executives had anticipated when they were raising that fund. (The firm ended up releasing investors in the $2 billion co-investment pool, earmarked for larger deals, from more than $1 billion of their commitments.) That led to a more diversified portfolio than Bain Capital would have liked, and diversification tends to be the enemy of out-performance.

Fund X also has had its first flameout—Contec Holdings Ltd, which Bain Capital acquired in 2008 from American Capital Ltd for around $525 million. Contec, a provider of repair services for users of cable TV and broadband equipment, filed for Chapter 11 protection in August 2012.

At the same time, the portfolio has also scored its first major exit, an IPO by the child-care chain Bright Horizons Family Solutions Inc., which Bain Capital took private for $1.3 billion in 2008. In January, the company went public again, raising $222 million in its offering and giving it a valuation of about $1.38 billion at the IPO price. Bain Capital did not sell any of its shares; it continues to own nearly 65 percent of the company, but it filed in November to sell 7.5 million shares, which would reduce its ownership to just less than 53 percent.

And, according to the investor presentation, the remaining portfolio is performing well. From 2009 to 2013 it pre-crisis portfolio companies have grown EBITDA at an annual growth rate of 7.9 percent, its post-crisis value investments have grown EBITDA at a 4 percent rate, its post-crisis growth investments have grown EBITDA at a 34.4 percent rate, and its emerging markets investments have grown EBITDA at a 9.4 percent rate. Bain Capital currently holds its Fund X portfolio at a 1.3x investment multiple (1.6x for pre-crisis deals, 1.3x post-crisis deals), and estimates it has generated a net IRR of 5.2 percent for investors. The firm expects the portfolio to reach a 2.5x when all is said and done.

As of March 31 the Regents of the University of California held Fund X at a 1.1x investment multiple and a 4.3 percent IRR. The 2007 vintage in the entire Buyouts fund database had as of year-end produced multiples of 1.1x at the bottom quartile, 1.3x at the median and 1.4x at the top quartile, while the corresponding IRRs are 4.4 percent, 8.9 percent and 14.3 percent

Prospective investors in Fund apparently like what they see. According to a source farmiliar with the firm, Bain Capital is just shy of raising $5 billion for the pool, and has a “line of sight” to getting to its $6 billion target by the end of next month.

(Correction: Bain Capital’s ninth fund is referenced in the first sentence of this story. The original version incorrectly referenced the tenth fund. Also, due to a production error the name of the company HD Supply Holdings was shortened beyond recognition.)