Annual fund raising has hit a five-year low with Q4 2009 being the worst quarter for new funds since Q3 2003. In 2007, at the peak of the market, European fund raising stood at US$65.9bn from some 90 funds, according to data from Prequin. In 2009, it shrank to US$36.7bn from just 26 funds. And while deal flow has also slumped, as we enter 2010 many of Europe’s largest firms can wait no longer.
This year may well be a make or break year for buyout fund raisers. There are a handful of funds in Europe which raised funds in 2005/2006 that are 60% or 70% invested so they will not be able to delay the process any longer. But these funds will largely have been invested at the top of the market and will, almost universally, still be valued at below par.
As a result many firms will struggle to raise new funds altogether and for others it may even be a franchise changing event. Among those waiting in the wings with previous funds raised between 2005 and 2007 include BC Partners, Cinven, Permira and Providence Equity Partners, which are predicted to be in the market by the end of 2010. Further out, Apax Partners, Bain Capital, Carlyle and GS Capital Partners look likely to tap the markets sometime in 2011. With their most recent funds raised in 2008/2009, CVC, KKR and Texas Pacific Group don’t look likely to come to market again until 2012.
As far as winners in this game are concerned, the big European names on LPs lips at the moment are Apax Partners, Cinven and CVC. Cinven, for example, looks in good shape and didn’t have a massive step up for its last fund, raising €6.5bn so expectations won’t be as high. One prominent European LP, who wished to remain unnamed, said: “Their last fund at the time was relatively modest. We are positive about the look of Cinven’s portfolio. It’s a fairly defensive portfolio and, at the operational level, it’s going strong.”
As well as a solid management structure and well equipped investor relations team, past performance also stands out for these firms. The 2001 vintage Apax Europe V fund has achieved an investment multiple of 2.04 and an IRR of 37% and still has investments in New Look, Travelex, Promethean and Smart; the 2001 vintage CVC European Equity Partners II achieved an investment multiple of 2.8 and IRR of 43% and the 2002 Cinven Third Fund achieved an investment multiple of 1.76 and IRR of 32.10%, according to figures from Thomson Reuters.
There are question marks over whether some of these larger buyout houses which raised mega amounts in the boom years will be able to get close to the amount of their previous funds.
News that Clayton Dubilier & Rice has just closed its eighth fund with US$5bn in capital may provide some encouragement to GPs. But the process has been a lengthy one for CD&R, which originally began fund raising almost two years ago and reduced its original target from US$7.5bn to US$5bn. However, the firm did still manage to raise more than the previous fund, which secured US$4bn in 2006, a feat that may prove difficult for other funds coming to the market.
Permira, for one, doesn’t look as though it will get anywhere near the €11.1bn figure it raised in 2006, which was reduced to €9.6bn in December 2008. The firm is likely to face numerous challenges on its next fund raising and may have to re-evaluate its entire business model, having lost its major investor (fund management business SVG Capital) and core members of its management team. Over allocation issues at SVG prompted the fund reduction at Permira whereby SVG capped its commitment to Permira’s fourth fund to 60% in exchange for a 25% drop in returns.
In 2005, SVG Capital and Permira agreed to formalise their relationship, with SVG Capital agreeing to be the major investor in both Permira IV and Permira V. Having lost this anchor investor, Permira now has the challenge of attracting the capital from a new investor base.
Helen Steers, partner at Pantheon stresses the importance of constructing a stable investor base for future fund raisings. “Some firms have been more insightful than others. Some aren’t totally reliant on one investor/trustee and have been more thoughtful about how they have put together their investor base.” Those managers, she says, will reap the benefits of those relationships.
One unnamed professional at a prominent buyout house says: “Because of allocation and liquidity issues, the re-up rate from existing investors is likely to be far lower than the historical average. For the good firms I would anticipate around 60% at most.”
Investors, concerned about a growing misalignment of interest, are also looking carefully at GP behaviour and are increasingly prepared to act with their cheque books. According to Coller Capital’s latest Global Private Equity Barometer Winter 2009-2010, over three-quarters of the 108 limited partners surveyed will refuse re-ups for new funds in 2010 due to concerns about inadequate GP reporting, fund terms and conditions and perceived conflicts of interest.
Many of the pension funds previously committed to private equity simply don’t have the capacity to increase commitments due to ‘the denominator effect’. That is, as the value of different asset classes — stocks and bonds for example — decreases, the value of allocations to other assets, including private equity, rises above allocation targets, triggering needed adjustments, that is, either sales or a reduction in commitments.
David Currie, chief executive of SL Capital Partners, says: “A lot of the public pension funds, particularly in the US, are still suffering from the denominator effect.” He adds that there may be some pension plans that may have committed €500m to a previous fund and now might commit less than €200m to the next fund. “There is simply going to be less money available to come into these big funds,” he says.
Andrew Sealey of placement agent Campbell Lutyens agrees: “The main fund raising challenge is that many existing LPs won’t re-up, and those that do are likely to commit smaller or significantly smaller amounts of money. Establishing new LP relationships will therefore be vital to success but very challenging in the current fund raising environment.”
On the other hand, some LPs predict a trend for institutional investors to write larger cheques to fewer funds and this will, in turn, accelerate the demise of those that do not make the grade. Helen Steers says: “There’s going to be a flight to quality. LPs will be going for safe bets. Anyone on the fringe and any managers with latent or obvious organisational problems will really struggle.”
New pools of capital
If, as looks likely, you will not be able to rely on existing investors, there is going to be a scrap to access new pools of capital. The obvious new sources are the sovereign wealth funds (SWFs), which have hitherto played a relatively limited role in backing private equity. These capital pools are deep and getting deeper. According to a report in November by accountancy firm Ernst & Young, sovereign wealth funds are poised to enter another period of sustained and impressive growth. Ernst & Young predicts that assuming an estimated growth in assets of some 12% to15% per annum, total funds under management by SWFs could climb from some US$3trn to US$8trn by 2015.
However, establishing relationships with these funds is a long-term game, placement agents have little traction, and you are unlikely to reap large benefits for a 2010/11 vintage fund if LP conversations are only just starting.
One interesting solution looks to be the deal that Apax Partners has signed with China’s sovereign wealth fund, China Investment Corporation (CIC). As well as acquiring unfunded comittments in Apax’s latest fund, CIC has bought a 2.3% stake in the management company alongside the Government of Singapore Investment Corporation (GIC) and The Future Fund, which had previously bought a 7.7% holding.
By having three of the largest and most sophisticated global investors in the firm’s capital structure Apax hopes to establish strong long-term relationships that will see them become cornerstone backers of subsequent funds.
On the up-side
Amongst all this gloom, there is some positive news – portfolio company returns have stabilised and rising stock markets have edged up valuations. There is also a long queue of portfolio companies being primed for the public markets, but it is too early to judge what boost this will provide for those that are planning fund raisings this year.
BC Partners has a highly publicised a string of its portfolio companies waiting for IPO, among which are global travel booking firm Amadeus, German chemical distributor Brenntag and Italian care home provider Medica.
The firm is in pre-marketing mode for its next fund, but has yet to specify a target. BC Partners didn’t really capture the big step-up in fund size for its last fund, BC European Capital VIII, which raised €5.5bn in 2005 and industry sources are speculating they might well raise a similar size fund.
According to a BC Partners spokesperson, BC European Capital VIII is approximately 70% committed, with a current value of 1.2X invested capital, and two limited partners that spoke to EVCJ said the BC Partners portfolio looks to be in good shape.
Data provided by Thomson Reuters reveals that past performance should stand the firm in good stead on this fund raising with both the 1998 vintage BC European Capital VI and 2000 vintage BC European Capital VII achieving investment multiples of 2.73 and 2.07 respectively.
However, the main challenge for BC Partners with this next fund raising is that investors will have to get their head round some significant management changes. Last year, the firm lost its chairman, Jens Reidel, who had been with the firm since 1992. He was replaced by co-chairs Francesco Loredan, who is based in Geneva, and New York-based Raymond Svider.
In preparation for the fund raising, the firm has ramped up its investor relations capabilities to create a seven-strong team led by Charlie Bott, who joined the BC investor relations team last year and will be replacing Kevin O’Donohue as head of investor relations.
One thing is certain, the fund raising market over the next couple of years will bring in to clear focus the winners and losers from the recession. Last year saw the very public demise of two prominent European buyout players – Candover and PAI Partners.
But given time, the tables can turn even for a manager in trouble. David Currie puts a positive spin on the situation for those troubled GPs. “The inertia of many LPs in terms of making a decision to sack a manager and replace them sometimes actually gives the current manager time to sort out their problems before any action is taken.” And so some GPs that have got into trouble may be out of the market for a while, but may re-emerge in a couple of years time when the market is more favourable and persuade investors to back them again.