U.S. buyout and mezzanine firms raised $64.8 billion in commitments last year, just a tad less than the $65.8 billion total from 2009, as investors toughened up on the terms they were willing to accept from general partners. Limited partners also continued their shift toward commitments to smaller buyout funds and away from mega-funds.
Investing in distress debt and turnaround funds remained a highly popular strategy, as the economy slowly warmed from a two-year freezeout. But regionally focused funds, especially those targeting China and other growth markets, overtook real estate and energy-oriented funds in popularity, while growth capital fell to the bottom of LP priority lists, according to an analysis of data collected by Buyouts.
Investors also showed a greater appetite for debt. LPs cut their equity commitments to buyout funds in 2010, to $56.8 billion, from $61.5 billion in the prior year, our data show, while increasing their commitments to mezzanine funds to $7.4 billion from $3.4 billion. Our fundraising totals reflect capital raised by U.S. buyout and mezzanine firms for LBOs, real estate, infrastructure, distressed-debt control and related strategies, regardless of the location of the transactions.
LPs have been chastened by their experience during the credit crisis, market watchers said. General partners still have an estimated $500 billion in dry powder, much of it raised during the boom years of 2006 and 2007, according to Prequin Ltd, the alternative asset data provider. (For the peak year of 2007, GPs still had more than half of their commitments uninvested as of year-end 2009.) During the credit crisis of 2008 and 2009, finding deals was difficult, and financing them was almost impossible. Still, in most cases, those fund managers have been collecting 2 percent management fees on commitments, including the uninvested portion.
The situation cuts investors several ways. For one thing, it limits their ability to make additional commitments to the asset class, because of pledges already made and still uncalled. It also means that they have not received returns by which they can judge the performance of the fund managers, nor can they reinvest those funds. And in light of the overall situation, they may not feel inclined to. In today’s market, the balance of power has shifted to the LP.
“GPs that have not returned capital are not getting funded. Groups that have not performed are not getting a free pass,” said Charles R. Daugherty, the managing partner at Stanwich Advisors LLC, a placement agent in Stamford, Conn.
As a result of the financial crisis, many LPs have put new processes in place to protect their investments. “Existing GP relationships are being more heavily scrutinized and underwritten the way new relationships are,” Daugherty said. “Say five existing GPs are coming back to market. They like four out of those five. They have enough money to fund two. That’s when the fun begins.”
Mega-firms have had a particularly hard time raising money, with giant funds largely out of favor with investors since the credit crunch. Commitments to funds with targets larger than $5 billion fell nearly 40 percent last year to $7.8 billion.
Even the biggest GPs have made concessions to their investors. In April, for instance, Apollo Global Management struck a deal with the California Public Employees’ Retirement System to reduce its fees for the separate managed accounts that CalPERS has with Apollo. The firms said at the time that the arrangement could save CalPERS $125 million over the next five years. The agency, the nation’s largest public pension fund with $213 billion of assets, has $2 billion under management with Apollo. Joseph Dear, the CIO of the $213 billion LP, said he intended to press the issue with other fund managers as well. And the agency set out new policies in May requiring GPs to improve disclosures about fees and other information about the placement agents they work with.
The Blackstone Group also struggled raising money for its latest buyout fund. When the firm went to market in the fall of 2007, it had a $20 million target for Blackstone Capital Partners VI LP, an amount it cut to $15 billion in August 2008, a month before the collapse of Lehman Brothers brought the financial crisis to a whole new level. It had appeared as recently as June that the shop had wrapped up fundraising at $13.5 billion, but Tony James, its chief operating officer, said in November that commitments had topped $14 billion and the firm would finish up close to $15 billion. The new fund is fully a quarter smaller than its vintage-2006 predecessor, the $21.7 billion Blackstone Capital Partners V LP, which in fairness remains the largest buyout fund ever raised.
Likewise, when Kohlberg Kravis Roberts & Co. returns to fundraising, probably this year, the firm plans to aim lower than the $17.6 billion that it raised for its last North American fund in 2006, Alex Navab, co-head of the firm’s North American private equity practice, said at the Buyouts Texas conference in November. That fund is about 70 percent invested. KKR launched two new funds in the fourth quarter, closing on $515 million for an infrastructure fund targeting $2.5 billion, and closing on $700 million for a planned $800 million China-focused fund.
Popular Strategies
With $11.9 billion in investor commitments last year, distressed debt and turnarounds remained the most popular strategy for the third consecutive year that Buyouts has tracked allocations by investing style.
“Distressed debt was a very popular area, especially when the crisis was occurring,” said Robert Carlson, a partner in the corporate practice of the New York law firm Paul, Hastings, Janofsky & Walker LLP. “The Oaktrees of the world have been doing extremely well. They’re hitting their fundraising goals, from what I can gather from the public record.”
Los Angeles-based Oaktree Capital Management LP, a specialist in distressed-asset investing, has been busy on multiple fundraising fronts. The firm topped its goal in one case, landing almost $4.5 billion on its $4 billion-target OCM Opportunities Fund VIII LP, which focuses on the distressed debt of large, overleveraged companies, but it fell short on its $3 billion-target Oaktree Principal Fund V LP with a final close of $2.8 billion, our data show. In addition, the firm closed on $952 million for its Oaktree Mezzanine Fund III LP, a $2.5 billion-target vehicle. And it returned to the market to start a new fund, the energy-focused, $800 million-target Oaktree Power Opportunities Fund III. Backers include the $14.3 billion Alaska Retirement Management Board and the $91 billion Teacher Retirement System of Texas.
Another firm that closed out a new distress fund was the Greenwich, Conn., turnaround firm Littlejohn & Co., which closed its $1.34 billion Littlejohn Fund IV LP above its $1.25 billion target and nearly at its $1.35 billion hard cap. The firm focuses primarily on North American industrial companies, and counts as investors Alaska Retirement Management, Employees Retirement System of Texas, and the $34.3 billion Maryland State Retirement and Pension System.
Comvest Investment Partners closed $76 million so far on a planned $300 million fund, its second distressed-turnaround fund. Although it launched in 1988 as an early-stage venture investor, the West Palm Beach, Fla., shop has raised $504 million in two previous funds since 2003 focusing on distress.
While plenty of distress remains in the market, some observers believe the best future opportunities may lie elsewhere. “A lot of money has been raised for distressed debt strategies,” said Daugherty of Stanwich Advisors. “There is a lot of money that’s already chasing it. There is a view that that market is pretty efficient.”
In search of inefficient markets where management expertise can make a difference, LPs are also choosing to play small ball. Micro-funds, those with targets of less than $300 million, more than doubled their commitments from investors last year, to $3.5 billion, while all their larger rivals saw fundraising setbacks. Investors have also migrated toward highly focused funds, both by investment strategy and region—a factor that has played right into the hands of The Carlyle Group.
The firm is marketing six different funds that focused variously on financial services, emerging markets including Asia and Latin America and real estate. The Washington, D.C., buyout megafirm held a final close at $1.1 billion, although well short of its $3 billion target, on its Carlyle Global Financial Services Partners LP, and a final close above $2.5 billion, again short of its $3.5 billion target, on Carlyle Asia Partners III LP. We tallied no 2010 closes on four existing funds, the $1 billion-target Carlyle Asia Growth Real Estate Partners II, which had raised $500 million; the $75 million-target Carlyle Latin America Real Estate Partners LP, which had raised $10 million; the $500 million-target Carlyle South America Partners LP; or Carlyle Realty Distressed RMBS Partners III LP, which had raised $22.4 million.
Another firm to have success last year with a highly targeted strategy was Global Energy Capital LP, an energy focused buyout shop in New York. The firm held a $93.2 million close in October on its in a $300 million-target fund. The firm raised an unspecified amount in 2008 for its inaugural fund, according to Thomson Reuters.
Another small firm, Boston-based Century Capital Management Inc. held a $155 million close on its planned $350 million Century Focused Fund III LP. The firm has a lower mid-market focus, offering buyout capital and growth equity to financial services, insurance and health care services companies. Its backers include St. Paul Venture Capital Inc. and Torchmark Corp.Another financially focused firm, Aquiline Capital Partners LLC, raised $475.6 million last year for its Aquiline Financial Services Fund II, which has a $2 billion target. The firm attracted 40 investors, including the Oregon Investment Council, in part by offering to allocate all of its deal and related fees to its LPs if it reaches its target. The firm invests in banking, insurance, asset management and financial technology companies.
The Denver buyout shop KSL Capital Partners, a specialist in travel and leisure businesses, won investments topping $100 million for a planned $1.5 billion pool, with a $27 million closing on KSL Capital Partners III LP, and an additional $77.5 million for a companion fund, KSL Capital Partners III TE LP. The firm was founded in 2005 by Michael S. Shannon and Eric C. Resnick, who had worked together at the resort operator KSL Recreation Corp. The firm has received backing from the Oregon Public Employees Retirement System, Oregon State Treasury and the Washington State Investment Board.
Seaport Capital LLC, a New York firm with a focus on media, communication and info-business, held an initial $200 million close for its Seaport Capital Partners IV LP buyout fund, The raise was a significant step up from its prior, 2005 fund, the $60 million Seaport Capital Partners III LP, yet smaller than its 2000 fund, Seaport Capital Partners II, which closed with $262.6 million, according to Thomson Reuters. The firm also launched a companion small business investment company vehicle, Seaport Capital Partners IV SBIC LP.
RoundTable Healthcare Partners, with a sole focus on medical devices and products, medication delivery systems, specialty pharmaceuticals, specialty distribution, and complementary outsourced services, quickly raised $600 million for its latest fund, RoundTable Healthcare Partners III LP, which it launched in January with a target of $500 million. Along with a captive mezzanine fund, the combined total reached $800 million for the Chicago-area firm.
Regional Funds
China was a popular area for buyout investing last year, as the Chinese government showed increasing willingness to partner with Western firms. KKR established units in Shanghai to launch a yuan-denominated fund, KKR China Growth Fund, raising $700 million last year toward an $800 million target. Other U.S. private equity megafirms, including Warburg Pincus, Blackstone, Carlyle and Bain Capital also have launched yuan funds, as did the investment bank Morgan Stanley, typically in partnership with local governments in China.
But international investing was not the exclusive province of the industry’s giants. Farallon Capital Management LLC closed on $233.5 million for an inaugural Asia focused special situations fund, USA!! according to an SEC filing. The firm, a San Francisco money manager with a multi-strategy approach, led the $128.8 million take-private of Wendy’s International in 2008.
Nor was the Far East the only area of interest; other emerging markets also found investors’ favor. Boston-based Advent International raised $1.5 billion last year toward a $2 billion target for its Advent Latin America Private Equity Fund V, which focuses on this hemisphere. The firm, founded in 1984, has focused other funds on central and eastern Europe and Japan.Even Europe, which has less appeal to investors than higher-growth regions, found some advocates. The Riverside Company closed its euro-denominated Riverside Europe IV LP at €425 million ($590 million), below its €550 million. Riverside, of Cleveland, specializes in small deals. Other out-of-favor strategies, such as growth equity, found support when their sponsors had a track record. JMI Equity closed its seventh fund, JMI Equity Fund VII LP, with $875 million in commitments, above its $800 million target. The Baltimore-based technology and software specialist has received backing from the Arizona Public Safety Personnel Retirement System, the New Mexico Public Employees Retirement Association and the Pennsylvania State Employees’ Retirement System.
For GPs in the mid-market, the keys to success in 2011 are likely to sound like Buyouts 101: Know your market and stay on mission; show some realizations and return capital to your LPs before you launch your next fund; demonstrate a skill set that differentiates your shop from others that may be chasing deals in your niche; and demonstrate the support of your existing investors before expecting much in the way of fresh capital.
“Until you have a close, it will be very difficult to attract new investors,” said Lyons Brewer, principal at LB Group LLC, an independent private equity placement and advisory firm in Westport, Conn. “You really need those LPs to support you.”
Market watchers said 2011 is likely to continue to be a tough fundraising environment for buyout firms, compared to the boom years in the middle of the last decade. The current level of commitments is generally consistent with what LPs were making in the early years of the new century.
The fundraising market has certainly improved from the early days of 2009, when the entire financial system appeared to be poised on the brink of collapse. Even so, more than 80 of the buyout funds in our dataset reported no progress on fundraising in 2010 for vehicles that already were in the market, compared to 73 in the prior year. Buyouts is currently tracking more than 200 funds in the market.
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