Following two years of furious fund raising and another year of economic turmoil, the first quarter of 2002 was the slowest quarter in recent memory for buyout fund raising, according to Buyouts.
As of last Tuesday, only two funds had closed on a total of $140 million in the first quarter. However, sources say J.W. Childs was scheduled to hold a first close on $1.4 billion at the end of last week, which would make the first quarter fund-raising numbers a little more respectable, but still paltry compared with previous quarters. The fourth quarter of 2001 saw more than $8 billion in closes while Q1 2001 saw more than $12 billion.
Industry sources say the snail’s pace of fund raising is reflective of several factors converging along the same time line. For one, the mammoth amounts of capital raised during the last few years – more than $60 billion in 2000 – have not yet cycled through the market. That process has been slowed by the lack of viable investments in a down economy. Add to that list the Sept. 11 attacks and a recipe for a bottleneck brews.
“The most important element is a general consensus on where the economy is,” says Christian Oberbeck, managing director at Saratoga Partners. “There was lots of uncertainty after Sept. 11.”
Funny thing is, besides J.W. Childs, the other significant fund to hold a close was a first-timer with a specific focus-two characteristics that can sometimes make or break an effort. RoundTable Healthcare Partners closed on the last $90 million of its $400 million fund in Q1, oversubscribed by $150 million. The fund’s four partners, led by former Allegiance Corp. CEO Lester Knight, have more than 100 years of combined experience in managing, operating, acquiring and financing health-care concerns. The firm gathered its money from 25 limited partners, while its partners contributed the largest portion at $22 million, which was a selling point to outside LPs. But despite the fund’s success, Knight says the market in general is not easy.
“People I’ve spoken with have expressed concerns with [pension fund] allocation, and a lot of firms are expecting major write-downs,” says Knight. “Firms are cutting back expenses, they’re trimming partners.”
This year’s buyout arena has displayed two moods, Oberbeck says. A huge portion of the industry has been tied up dealing with restructuring, fixing the “problems from a prior era,” he says. The other mood that emerged this year has been that of optimism, focusing on the future and realizing times are ripening for new investments. “We have the view that now things seem to be stabilizing,” he says.
How Low Did It Go?
It’s possible that the severe lack of activity last quarter may signify the rock bottom both LBO firms and banks have been waiting for – a true turning point for the market. Looking back over previous quarters in recent years, including those that showed decline, none have come close to replicating Q1’s results.
Since 1995, not a single quarter has recorded less than $3 billion in fund-raising activity, and the closet any quarter has come to doing so was Q1 1996, when $3.3 billion was committed, according to Buyouts data. It’s only fair to mention again, however, that 2000 was an over-the-top fund-raising year when many heavy-hitters took in billions of dollars, therefore not yet needing to come back to market. Last year wasn’t so shabby either. That’s not to say that there aren’t a good number of funds still in the market, including some brand names, that we haven’t heard from in a while, including Kohlberg, Kravis, Roberts & Co., Welsh, Carson, Anderson & Stowe and Joseph, Littlejohn and Levy.
If the buyouts market indeed hit its lowest point last quarter, such news is actually good. The economic recession appears to have drawn to a close, according to remarks from Federal Reserve Chairman Alan Greenspan. Furthermore, consider that the venture capital and initial public offering markets, both of which hit low points in 2001, have begun to produce more positive deal flow in recent weeks. In short, this dismal quarter may mean the buyout market has found a solid foundation from which to build on, rather than continuing to anticipate how much worse it can get.
“It appears we have established a bottom. It has the characteristics of a bottom,” Oberbeck says.
Big Funds: Fewer and Slimmer
With LPs hitting their private equity allocations and exerting downward pressure on management fees, it’s not surprising that there is little appetite these days for billion-dollar-plus campaigns. Mega-fund investment strategies all but stalled with the end of the economy’s long bull run. Of the new fund-raising announcements made last quarter, three funds had targets of $500 million or less.
Leeds Weld & Co. is currently raising for Leeds Weld Equity Partners IV, which carries a $500 million target. H.I.G. Capital began fundraising for H.I.G. Capital Partners III with a target of $400 million. And The Carlyle Group is looking to raise $500 million for its first turnaround fund. Only The Jordan Co. has pledged to round up $1 billion.
“The buyouts business is going through quite a bit of change. The fundamental change is that people are realizing you have to do more than financial engineering to make a return,” says Chris Brotchie, CEO of Baring Private Equity, which saw success with its international funds (see story p. 20). “The view today is, that’s no longer a viable offer.”
Only a select few will continue to bring mega-funds to market, says Oberbeck.
“Only in the 1990s really was it routine to have multibillion-dollar buyout funds, and the record is mixed on them,” he says. “Not all are bad, but not all are good. There’s revived interest in focused investments.”
So perhaps RoundTable’s fund closing was well timed. A growing disdain for mega-funds, coupled with the defensive positioning health-care investments carry, gave the new team the boost they needed.
“The smaller [funds] have a lot more interest, as investors could clearly see where we were going to invest the fund,” says Knight. “Plus, due to the technology investing, allocations were all out of whack. Now they’re trying to get those allocations readjusted,” he says.
Middle Market Weighs In
The sweet spot for this year, most buyout investors noted, was opportunity in the middle market. Lost in the frenzy of massive fund raising over the last two years, middle-market investments, heralded as birthing the LBO market in the first place, appear to be cycling back into favor. Two GPs contacted for this story confirmed that banks they have contacted are willing to open up financing again, but only to deals targeting mid-market companies in traditional industries.
Meanwhile, in Europe the bulk of middle-market deals are expected to come from consolidation due to the introduction of the euro. “There are several industries with just too many manufacturers. You just know that there will be consolidation,” says Baring’s Brotchie. “We’ve found some wonderful opportunities in Europe, especially as Europe consolidates as one market behind the euro.”
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