And while there is a fast-moving HOV lane, only 10 to 20 percent of general partners—those with stellar performance and sterling brands—are allowed on. Everyone else is left to wait it out, turn around, or run out of gas. For many GPs stuck in the great 2012 fundraising traffic jam, now may be a good time to rethink the road ahead and adjust expectations accordingly.
But first, the numbers. The total amount of fresh capital raised by U.S. buyout and mezzanine funds in the first quarter fell by 28 percent to $26.5 billion from $36.6 billion in the fourth quarter of 2011. The first-quarter tally was up 44 percent from an anemic $18.3 billion raised in the first quarter of 2011. But a close look at the data shows that this quarter’s tally would actually be below last year’s had it not been for two mega-fund interim closings. Figures from Buyouts include money raised from both interim and final fund closings.
By strategy, U.S. buyout firms registered $22.7 billion in closings in the first quarter. That was down 36 percent, or $13 billion, from the fourth quarter of 2011, but up 36 percent, or $6 billion, from the first quarter of 2011. Mezzanine funds raised $3.7 billion in the first quarter, but 96 percent of that money came from a single fund, the $3.6 billion GSO Capital Capital Solutions Fund II from The Blackstone Group.
Looking ahead to the rest of 2012, most private equity fund managers and placement agents predicted the overall amount of money committed to U.S. sponsors would not veer too much from the $98.7 billion raised in 2011 and remain far below the totals raised in 2007 and 2008.
Bottleneck Causes Slowdown
The main story of the first quarter wasn’t the tepid amount of cash being pledged. Rather, it was that GPs were persistent in driving onto the crowded fundraising highway, knowing full well it was already backed-up.
As limited partners concentrated their new investments with smaller groups of branded outperformers, this fundraising bottleneck is likely to have stark implications for the number of firms the industry can sustain.
“There will be many disappointments,” said Antoine Dréan, the founder and chief executive of Triago, a Paris-based placement agency. “Some GPs have been in the market for a while already. And some guys have been on the sidelines for years, waiting for better times. But better times haven’t come, and because these guys want to stay in business, they have to start fundraising. So, this traffic jam will worsen, actually.”
“People are now talking about two-year fundraising efforts,” said David Fann, chief executive of Torrey Cove Capital Partners, which advises investors like the Oregon Investment Council and the Illinois Teachers’ Retirement System on their private equity portfolios. “Far less than half the funds in the marketplace are getting any traction,” he said.
Just how many funds are in the market right now? According to Preqin Ltd., the alternative asset data provider, there are now 1,847 private equity funds in the market globally, compared to 1,676 at the start of 2011. Those funds are seeking to raise $784 billion, 15 percent more than the $680 billion the industry sought to raise at the beginning of 2011.
The flip side of this imbalance is that funds with marquee brand names and stellar performance are finding fundraising a breeze.
Carl Thoma, whose Chicago-based firm, Thoma Bravo, just closed its tenth fund with $1.25 billion in commitments after a five-month fundraising, said “if you’ve got upper-quartile performance, a stable general partner, and a strategy you can articulate that gives investors the feeling that you can continue to deliver upper-quartile performance, for those groups it’s easy to raise money.”
Fundraising right now is a paradox, said Torrey Cove’s Fann. While some investors have increased allocations to private equity in recognition of its strong performance compared to other asset classes, “the paradox is that large institutional investors are trying to reduce the number of firms in their portfolios, adopting a core/non-core view of the world. And the core names they want back are consistent out-performers.”
These efforts to concentrate portfolios are having a sharp impact on re-ups, said Mounir Guen, the founder and chief executive of MVision, a placement agency. “Fund attrition, the portion of fund investors who don’t re-up, is now about 40 percent,” he said, adding that this was higher than in previous years.
But fund concentration wasn’t the only reason the battle for capital has been fierce: LPs are also writing smaller checks. Said Guen: “The mega investor that used to write $350 million tickets is now writing $150 million tickets, maybe $200 million, if you’re lucky.”
Moreover, said Triago’s Dréan, most LPs were either fully allocated or over-allocated to private equity. That means, “there’s not a lot of new money out there for PE funds,” he said.
Separate Accounts Shake Up Market
And then there’s a fundraising X-factor: separate managed accounts.
Late in 2011, the Texas Teachers’ Retirement System committed $3 billion each to Kohlberg Kravis Roberts & Co. and Apollo Global Management, while the New Jersey Division of Investment committed $1.5 billion to Blackstone Group as part of separate managed accounts.
Some observers, like Torey Cove Capital’s Fann, believe such moves, if they were to become common, could siphon money away from traditional private equity firms and concentrate it in a few industry giants with diversified asset-management capabilities, include areas that have little to do with private equity.
Because of these separate account deals, “there is less available capital for the other guys, and more competition for a smaller piece of the pie,” said Fann. “In other words, some firms will be penalized for being sub-scale players in the marketplace.”
Industry insiders say look out for more separate account deals in 2012. The most likely candidates, they say, include the California Public Employees’ Retirement System and the California State Teachers’ Retirement System.
Ultimately, said Fann, what’s going on is “Darwinism and the ‘survival of the fittest.’ There will be sub-scale funds that won’t make it, and funds with marginal performance won’t make it. Nobody ever said to us that they want to invest in a good fourth-quartile fund.”
How many funds won’t survive? Triago’s Dréan estimated between 25 and 50 percent of all private equity funds will dissolve or morph into something else. “There will be many spin-offs, and many funds will just close shop because they won’t be able to raise money going forward.”
Fann agrees, estimating that the bottom 10 percent of firms each year will just evaporate or manage themselves out. “They’re never going to write a press release saying they are folding the franchise; they’ll just disappear,” he said.
Of course, private equity’s survival instincts have always been strong. One common survival strategy has been to seek less money. Three of the largest firms in the marketplace have sought to raise funds that are half or even less-than-half the size of their predecessor funds.
One such fund is the latest offering from Providence Equity Partners, the media and technology specialist. The Providence Equity Partners VII LP is seeking to raise $6 billion, just half the $12 billion that the firm raised for Fund VI in 2007.
Another is Cerberus Capital Management’s latest flagship fund, Cerberus Institutional Partners LP, Series Five, which is seeking $3.75 billion, just half the $7.5 billion raised by its previous fund, which also closed in 2007.
Finally, KKR is seeking $8 billion for its newest flagship fund, KKR North American XI Fund. That is less than half the $17.6 billion it raised for its previous fund, which closed in 2006.
Moreover, raising less than your target isn’t the stigma it once was. Said Thoma: “If someone goes out there to raise a $7 billion fund and only raises $5 billion, you can say they actually did pretty well. But that does contribute to the general feeling that it’s harder to raise money.”
Popular Strategies
Triago’s Dréan said the most popular areas right now are in distressed debt and turnarounds, given the recent fallout from Europe’s credit crisis. “This is not a big surprise,” he said. “It’s probably the flavor of the year and probably for years to come. There is a lot to be done on the restructuring side, both in equity and debt.”
As part of that effort, several buyout shops have set up funds specifically designed to take advantage of Europe’s debt crisis, especially the loans likely to be offered by Europe’s undercapitalized banks. Among the new European distressed debt funds in the market were the Apollo European Principal Finance Fund II LP, which was seeking $3.3 billion, Oaktree Capital Management’s OCM European Principal Opportunities Fund III, which was targeting $4 billion and Avenue Capital Group’s Avenue Europe Special Situations Fund II, which was seeking $1.5 billion.
And there is one area where there has been more investor demand than a quality supply of funds, said MVision’s Guen, and that is emerging markets. Many large investors were boosting their emerging market allocations, he said, from less than 3 percent of their private equity portfolios to 15 to 20 percent. Because of this, he added, “in emerging markets, there is excess cash, because there are not enough experienced general partners in the marketplace to absorb the cash that’s floating around.”
And no emerging market area has drawn more excitement in recent years than Asia, and specifically, China. Among the funds that closed in the first quarter was Hony Capital’s Hony Capital V LP, which raised $2.4 billion, a record for a China-based private equity fund. Among the investors in the fund were the Los Angeles City Employees’ Retirement System and the New York State Common Retirement Fund.
Not to be outdone, KKR has waded in the market with its second Asia focused fund, KKR Asia Fund II LP, which was seeking to raise between $4 billion and $6 billion. This fund has already picked up a $400 million check from the Washington State Investment Board.
And what is the sweet spot for private equity funds in terms of size? In recent quarters, it was funds raising between $1 billion and $5 billion. But because tabulations vary widely depending on when closes are actually announced, in the first quarter of 2012, mega-funds (those with targets above $5 billion) was the area that attracted the most capital.
But there is an asterisk. The money raised by mega-funds in the first quarter came from just two funds—KKR North American XI LP and Blackstone Real Estate Partners VII LP (which is targeting $10 billion). Interim closes by these two funds registered $9.6 billion in commitments, which was nearly the entire amount—$10.1 billion—raised by mega funds in all of 2011.
Adding To The Traffic
Despite this flashing “traffic ahead” sign, a number of firms got back on the fundraising highway in the first quarter. Among them was The CarlyleGroup, which is seeking to raise its latest flagship fund. This fund, Carlyle Partners VI LP, will likely be focused on U.S. buyouts. It is seeking to raise $10 billion.
Another new fund to the market in the first quarter was the latest flagship from Silver Lake Partners, Silver Lake Partners IV LP. According to Bloomberg News, the fund has a $7.5 billion target and offers management fees as low as 1.375 percent for LPs willing to commit at least $500 million.
Advent International began raising its newest flagship fund, Advent International Global Private Equity VII LP, during the first quarter. The fund, which is targeting $9.4 billion, will stick with the firm’s investment focus across a variety of geographies and industries.
Oaktree Capital Management, a debt specialist, has already made headway on its newest $4 billion flagship fund, Oaktree Opportunities Fund IX LP, which it started raising in the first quarter. The fund has secured $400 million from the Washington State Investment Board.
Finally, TowerBrook Capital Partners started raising its newest fund, TowerBrook Investors IV LP. The firm is seeking to raise $3 billion.
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