By most accounts, 2005 should be a banner year for fundraising, or at the very least a banner year for firms trying to raise funds. And nothing motivates private equity shops to sell quite like a fundraising drive. Couple that with the trifecta of a stout financing market, economic strength and rising purchase price multiples, and the exit market in 2004 proved to be a bonanza for sponsors and their investors alike.
“From a return aspect, 2004 was a terrific year,” says Hamilton Lane Advisors Chief Investment Officer Erik Hirsch.
Kohlberg Kravis Roberts & Co. and The Carlyle Group, for example, together dispensed more than $15.5 billion to their limiteds over the past 19 months, while Warburg Pincus meted out a reported $1.6 billion.
The exits came in all shapes and sizes. Financial sponsors were again a favorite outlet for their peers, but 2004 also saw strategic acquirers roused to attention, and the IPO market finally got wedged back open. Perhaps most notable last year was the partial exit via a dividend recapitalization. The strong high-yield market created an opening to refinance, which allowed firms to take cash out of investments while maintaining an ownership stake for future gains.
In one of the more bountiful recaps, KRG Capital Partners was able to pull out 110% of its $21 million investment in Civco Holdings, while maintaining an 80% stake in the medical device maker it had acquired just barely one year earlier.
As much as sponsors appeared to delight in the recap, there were some detractors, and buyout shops were left answering old qualms concerning, just how leveraged is over-leveraged?’
“The good news is that we got cash back, and we got it quicker, with money still left on the table,” Hirsch says. “But the question is, What does this do to the overall leverage on those companies and will that ultimately cause problems down the road?'”
Steven Liff, a principal with Sun Capital Partners, argues, “Leveraged recaps are a great way to realize a return and keep IRRs up… The good thing about being a private equity firm is we’re used to living in a leveraged environment, and if it turns out that a company is getting pinched [financially], there is an untapped source of capital at our disposal. There’s always liquidity if needed.”
Other Avenues Open
Private equity firms were also busy orchestrating full exits last year, and with so many of their peers buying, the splurge of secondary sales was destined to occur. Private equity buyers had become a trusted outlet in past years as the strategics searched inward and the IPO market disappeared. And like past years, strong returns continued to be found. Cypress Group’s nearly 200% profit on its Cinemark investment, which was acquired by Madison Dearborn Partners, serves as proof of that.
“I’ve seen more sponsor-to-sponsor transactions in the last half of 2004, than I’ve ever seen before,” Patrick Haden, a general partner at Riordan, Lewis & Haden, says. “It used to be that private equity firms were distrustful of each other, but now people realize that everybody has to deal with an investment life.”
Strategic activity has also ramped up. Domestically, corporations have finally gotten their houses in order and will need to start showing growth again. The foreign corporates have also started making eyes with U.S. companies, emboldened by a weak dollar. All this has been to the benefit of buyout shops. WL Ross & Co., for instance, cemented a 12x equity return on its International Steel Group investment, which will be sold to Mittal Steel Company.
“We’ve seen a number of foreign players enter auctions, increasingly using the strength of their currency to their benefit… and we’re also seeing domestic strategic acquirers come into auctions with much greater force,” Barrington Associates Managing Director Eduard Bagdasarian says. “[The M&A market] is no longer all private equity driven.”
Also an exit option, and an increasingly appealing one, are the public markets, which opened up in 2004 (see story page, 24). Bear Stearns Merchant Banking Partners, Apollo Management, and Blackstone Group are just a few of the firms to have found success there.
As pros look ahead into 2005, most are anticipating private equity firms will continue to unload investments, and some expect the pace in doing so will even pick up more steam. “With these partial exits, if you’ve played the recap card in 2004, the only other realization cards to play for the next couple years are an outright sale or an IPO…,” says Gryphon Investors Managing General Partner David Andrews. “With so many funds again coming to market, you know that many LPs will be putting a premium on cash returns, so some sponsors will have to emphasize cash exits if they want their fund raising to be completed quickly.”