Fundraising Holds Steady In Third Quarter

U.S. buyout firms and mezzanine firms raised $74.0 billion in the third quarter, roughly in line with the $74.3 billion they raised in the second quarter and the $68.0 billion they raised in the first quarter. A full $214.8 billion of the 2007 total of $216.3 billion raised to date comes from buyout funds, with the balance being raised by mezzanine funds.

The supply of LBO funds that limited partners can choose from remains enormous, most of them in the smaller and mid-market range. Buyouts has tracked 275 funds that have been in the market this year. Of those which have known targets, the123 buyout funds with targets of less than $500 million have raised $12.9 billion. The 76 funds with targets of between $501 million and $3 billion have raised $60.9 billion. And the 36 funds with targets of $3 billion and above have raised $129.5 billion through the third quarter.

Year-to-date, the $214.8 billion LBO firms with headquarters in the United States have raised surpasses the $200.4 billion domestic LBO funds raised in all of last year. Big funds to close in the third quarter include Fortress Group’s Fortress Investment Fund V, which closed with $5 billion in commitments, including a co-investment fund; and Blackstone Group’s $21.7 billion fifth fund, which closed after a fundraising process stretching back to 2005. Blackstone also said in the third quarter it has raised $10.2 billion for its sixth real estate fund, while the Carlyle Group has moved the needle with $11 billion raised so far this year for its fifth general purpose buyout fund, which bears a target of $17 billion.

A collapsing credit market in the third quarter had pundits and pros alike talking about diminished prospects for firms targeting the highest end of the deal market. Whether the fundraising market maintains its pace will depend largely on the fortunes of these mega-funds, which have been driving so much of the gaudy fundraising numbers of late. “I do think the brand names will hit their targets,” said a partner with a multi-national funds-of-funds manager who didn’t want to be named because of his relationships with large funds. “But they’ll probably have to work a little harder than six to twelve months ago.”

Bain Capital, for example, is in the market with a $10 billion main fund and a $5 billon co-investment fund. The last time it came to market with a fund, in early 2006, it cooly raised an $8 billion main fund and a $2 billion co-investment fund in a few months. The firm has never had to struggle to raise capital, say observers.

But this time, “the fundraise will be slower,” said a source close to the firm. Our source explained that a lot of LP allocations are already spoken for at this time of year, and there’s a lot of other funds in the market. LPs have told Buyouts that Bain Capital is casting a wider net for fund X, one that is likely to include more pension funds than previous Bain Capital funds. According to one placement agent, Bain Capital is also contacting placement agents to try to recruit new professionals to bolster its in-house fundraising team. Bain Capital declined comment.

Other mega-funds in the market include Warburg Pincus Private Equity X, with a target estimated at $15 billion; and Madison Dearborn’s sixth fund, with a target of $10 billion. Thomas H. Lee Partners and Silver Lake, meanwhile, are both close to closing on at least $8 billion with their latest partnerships. Other massive funds still open include the KKR 2006 Fund, which has collected more than $18 billion so far. All of these firms declined comment on their fundraising.

“Mega-funds are here to stay,” said Mac Hofeditz, a partner with placement agent Probitas Partners. “They are an efficient way for private equity investors to allocate lots of capital. It’s easier to give $300 million to Blackstone than to give $30 million to 10 lower-middle-market buyout firms.” That efficiency seems to carry at least as much weight with investors as potential returns: Investors know that they could likely get higher returns in sub-$500 million funds, where there is less competition on deals, said Hofeditz.

That said, LPs have voiced some regret to Hofeditz about the commitments they hastily made to larger funds over the last year. And Jeffrey Heil, chief investment officer of the Doris Duke Charitable Foundation, recently said that given the situation in the debt markets, the foundation has decided to sit out at least one round of contributions to large buyout funds, such as Bain Capital Fund X and TPG Partners V. In response to current credit market conditions, “We are passing on some current commitments, but not all. Just want to reduce our exposure some,” Heil wrote Buyouts in an email.

Smaller funds, meanwhile, can hardly repress a bout of schadenfreude at the debt pull-back, which has cast a shadow on the ability of large funds to generate outsized returns. The smaller funds see this as an opportunity to grab LP attention and point investors to the middle market where they say credit problems haven’t stopped deals.

One buyout pro that has raised $500 million so far for a debut fund, more than half-way to his target, said, “In my last month of meetings with LPs, everyone’s thinking, ‘Maybe we overindulged a bit’” backing mega-funds. On the margin, he said, that’s a positive for his lower-middle-market fund. He, like many others, contend that debt multiples have not retracted so strongly for smaller deals.

Another first-time GP raising a sub-$500 million said he has prepared a presentation sheet to give to prospective LPs explaining how the middle market and lower middle market are less affected by a credit pull-back.

“We do get asked the question a lot about [whether] we have been able to obtain debt financing,” he said. “We’ve written up a little page on it. We are still able to get deals done is the answer we give them. The footnote is that it’s gotten a little more expensive.”

What’s Hot: Energy And Distressed

Of the niche areas that are attracting LP interest, distressed debt funds, turnaround funds, and energy funds stood out in the third quarter.

All told, Buyouts is aware of 13 energy buyout funds that have raised more than $13 billion so far this year. Among those that have closed are EnerVest Partners XI, which closed with $1.02 billion; Energy Investors Funds’s United States Power Fund III, which closed on $1.35 billion; LS Power Equity Partners II, which garnered $3.09 billion in commitments; Quantum Energy Partners IV, which garnered $1.32 billion; and Quintana Energy Partners, which closed with $650 million in commitments. One of the larger funds in the market, NGP Energy Capital’s Natural Gas Partners IX, is already $2 billion deep into a $3 billion targeted fund.

Distressed debt and turnaround funds have also been resonating with LPs. Highlights from this year include CarVal Investors’s CVI Global Value Fund, which raised $5.75 billion; Cerberus Institutional Partners LP Series IV, which closed on $7.5 billion; MatlinPatterson Global Opportunities Fund III, with $5 billion; Goldman Sachs Distressed Opportunities Fund III, with $1.29 billion; Oaktree Capital Management’s OCM Principal Opportunities Fund IV, with $3.3 billion; and Morgan Stanley Global Distressed Opportunities, which closed with $500 million. All of these are final closes. Distressed debt and turnaround funds have closed on over $23 billion this year, according to Buyouts data.

Meanwhile, a number of other funds targeting companies in jeopardy remain in the market. As reported in Buyouts, Michael Heisley, owner of Heico Cos., recently teamed with Jeff McDermott, former co-head of investment banking at UBS, to form Stony Lane Partners, which plans to raise $750 million to buy troubled companies. Dallas-based Treadstone Partners also plans to come to market this year with Treadstone Capital Partners II to invest in distressed securities. Meanwhile, distressed investor Wayzata Investment Partners lurks in the market with Wayzata Special Opportunities Fund II, having raised roughly $1 billion of a targeted $2.5 billion.

By the end of the year we should know just how much impact the credit crunch has on the fundraising market. Meantime, a number of observers told us that the development could actually make for a much improved LBO environment from an LP’s perspective.

“If I had money to spend on buyouts I’d much rather have it now than two years ago,” said a placement agent who did not want to be named. “It’s been a seller’s market for the last two years and companies have been trading at the high end of the spectrum. Now the multiples are finally coming down. Late 2007 and early 2008 will be very good vintages.”