It’s a comeback story that couldn’t be scripted any better. After raising a record level of capital between 1998 and the end of 2000, the buyout market got knocked sideways after the economy went into recession. Just two years ago when investors discussed the market, the enveloping uncertainty was exactly how or even if the industry could ever chip away at the more than $100 billion overhang.
However, following two of the busiest years ever in the buyout market, not only has the industry been able to put a record amount of money to work, but it’s also done a pretty good job returning capital to LPs. And just two years after people were talking shakeout, now that it’s again time to reload, there are lines of limiteds with their hands up trying to make investments.
John Tomes, a president and managing director at Hilco Equity Management, who spent roughly a year raising the firm’s inaugural fund, notes that the difference between the marketplace 12 months ago and the current market is almost night and day. “On our first day of fundraising, many of the meetings were dominated by the limiteds listing the dirty laundry of their previous investments. As we got toward the end, here, people put their hats back on and started investing again. It was pretty dramatic,” he said.
Indeed, now limiteds are scrambling just to keep up with their stated allocations. One LP, in describing the difficulty, told Buyouts, “It’s like trying to run uphill.” Meanwhile, new fund of funds crop up every day, and institutions that didn’t previously invest in private equity have quickly become converts. Pension systems in New York City, Mississippi, New Jersey and New Mexico, for instance, are just a few of the new institutional investors that jumped into the asset class. Additionally, a study by The Commonfund Institute indicated that on average, alternative investment allocations jumped to 18% last year, versus 14% in 2003. This all bodes well for the fundraisers.
“There have been a lot of distributions, and that has really put some more liquidity in the market,” says Stephen Perry, a senior managing director at Linsalata Capital. “Private equity also appears to be edging up in the [LP] allocation models.”
On top of that, Hamilton Lane CIO Erik Hirsch tells Buyouts, “Overall, people are sitting in a better net position with their portfolio. There’s also a real search for return going on, and people aren’t finding it in other areas of the market. They’ve seen it and found it in private equity.”
With the asset class in demand, buyout shops are only too happy to oblige, and this surge of LP interest is propitiously timed with the historic five-year blip in the LBO fundraising cycle. Moreover, investment bank spinouts and first-time funds have also mobbed the marketplace, giving LPs an even more extensive list of options.
As Buyouts’ Q2 data shows, there are more than 265 buyout funds that have either closed in 2005 or are currently in the market. In sum, LBO groups are targeting roughly $167 billion for their latest funds and have already raised a total of $79 billion in capital. If that list is extended to include mezzanine funds, secondary funds and fund of funds, then there are more than 325 funds in the market seeking $187 million, with $93 million worth of capital already closed on.
The headline grabbers, to be expected, are the mega funds. Blackstone Group, Apollo Management, Carlyle Group and others, in addition to generating a disproportionate amount of press, make up a giant chunk of the total market. If the targets given for the 15 largest funds are met, that would account for 45% of all the capital raised by the 266 funds in the market (if all targets are reached).
In terms of regional focus, buyout shops continue to find success with funds targeting foreign shores, especially with funds devoted to Asia. CVC Capital Partners set a $1 billion cap on its second Asia Pacific fund, but ended up raising more than $1.97 billion, and JPMorgan Partners has reportedly laid out plans to unveil its own $1 billion Asia-focused fund.
It’s the Cycle, Stupid
To be sure, the environment is as competitive as it’s ever been. LPs are worried about getting shut out from the best performers, while the buyout shops, even in a market awash with capital, can find it difficult to distinguish themselves from the 300-plus other funds in the market.
Troy Templeton, whose firm Trivest isn’t even fundraising, notes that this past winter he was receiving around five unsolicited phone calls a week from potential LPs.
Meanwhile, speaking to the competition among GPs in the market, one pro observes, “The LPs almost seem overworked. They talk about the number of PPMs they receive, and we can see it with the number of due diligence books sitting on their desks.”
With that said, even if the limiteds appear overworked, GPs are finding that it’s becoming more difficult to put one over on them. Compared to the last time many of these firms were in the market, the LP community has grown up in terms of sophistication, and no longer is fundraising merely a game of follow the leader. According to most pros raising money, there are few if any LPs that aren’t keeping up with their homework.
“It used to be that some of the more notable investors would do the due diligence and others would just follow them,” one GP says. “Now everybody is doing a huge amount of due diligence, whether they’re investing $10 million or as much as $100 million.”
Despite the increased scrutiny, or perhaps because of it, the standout funds manage to raise capital seemingly at will. There have been a number of cases in which funds have closed before many in the market even knew they were open. Apollo, reportedly boasting gross returns of 78% from its previous fund, is said to be nearing its final close in the coming weeks, after less than a quarter officially in the market. Charlesbank Capital was another fund that was already raised before most people even had a chance to peruse its PPM.
However, while these funds are heralded at their close, there are others that go from “in the market” to “out” mysteriously overnight. Earlier this year, market sources had indicated that Willis Stein & Partners was raising its fourth fund, yet representatives for the firm insist it is not in the market. Meanwhile, in December, William Cohen, the Carlyle Vet and former U.S. Defense Secretary, was quoted in a Financial News Online story saying that his new firm TCG Financial Partners was in the initial stages of raising a $300 million inaugural fund. A recent call to TCG CEO Edward Carter, however, proved otherwise, with no rationale given for the about-face.
In their defense, the regulators have buyout pros increasingly touchy about questions concerning fundraising. Some offer a polite “no comment,” while others are offended reporters would even ask. Because of this, it can be difficult to discern whether funds are just safeguarding themselves from the SEC’s heavy hand or have actually had to go back to the drawing board before approaching LPs again.
But when all is said and done, there will be a number of firms seeking capital today that fail to reach their stated targets. No matter how flush the market appears, there isn’t that much capital available, and even if there was, history suggests more than a few limited partners would end up disappointed with their investments were every fund to meet its cap.
“The amazing thing is if you look at the asset class for a long period of time, say 10 to 15 years, and take all the buyout funds over that time, the performance of private equity would actually lose to the S&P 500 over the same stretch. This is lost on a lot of investors,” Hamilton Lane’s Hirsch says. “If you’re not getting into the top tier of the market, this isn’t really that great of an asset class.”
He adds, “There are some groups out there that are elevating the caps [on their funds], that have never beaten the S&P, never been in the top quartile and have never made any money for their investors, but they still continue to get capital.”