For a very few private equity shops in fundraising mode, especially those with a fashionable strategy and marquee-name partners, 2009 represented a winter wonderland. For everyone else, it was a frozen tundra, with no thaw in sight.
U.S. buyout and mezzanine funds collected a mere $64 billion in 2009, down 75.8 percent from $264 billion last year. The amount falls between the $33 billion raised in 2003, which marked a multi-year trough in fundraising, and the $72 billion assembled in 2004. In contrast, firms amassed about $300 billion at the height of the boom in 2007. 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.
The implications of the slow fundraising market on the private equity market, including service providers, are vast. Firms facing longer fundraising periods can’t collect management fees on capital they haven’t clinched; they can’t jump on great deals that may come along; they must spend more time and energy marketing themselves, possibly to the detriment of portfolio companies that need tending to; and without limited partners, they don’t hire service providers, such as legal advisers, to draw up LP agreements.
One of the most prominent themes in fundraising this year was the flight to energy-focused funds. The winner in this popular category was Energy Capital Partners’s second fund, Energy Capital Partners II LP. Since its introduction in December 2008, the firm has raised $1.75 billion towards its target of $3.5 billion. Earmarked for investments in North American energy infrastructure, mostly in the power generation, renewable energy, electric transmission and midstream gas sectors, the firm has received pledges from several big pension fund investors. The California State Teachers’ Retirement System and the New York State Teachers’ Retirement System each committed $100 million. And the San Francisco Employees’ Retirement System pledged up to $20 million to the fund in mid-October.
The Indiana Public Employees’ Retirement Fund committed up to a $75 million to Energy Capital Partners I LP in 2006 and pledged $40 million to Fund II. The LP stated in its board documents in 2006 that a seasoned team with a demonstrated track record had created the first-time fund. Doug Kimmelman, Scott Helm and Thomas Lane, all originally from Goldman Sachs, founded the firm in 2005. And the Short Hills, N.J.-based firm’s performance with Fund I, which closed in 2006 with $2.25 billion, surely attracted attention. According to CalSTRS data, the IRR of Fund I, as of March 31, 2009, was 13.6 percent.
Secondary vehicles also saw some love from LPs who wanted to buy into funds at an attractive discount. One of the year’s more popular secondary vehicles is Lexington Capital Partners VII, which so far has gathered $2.7 billion on its way to its $4 billion target. Marketing for the fund began in the summer of 2008. The Hartford (CT) Municipal Employees’ Retirement System committed $10 million in May. Maryland State Retirement and Pension System pledged $100 million. Lexington Partners specializes in secondary funds and buyout transactions via co-investment vehicles.
One of the reasons for the slow fundraising market has been the quiet deal front.
Fewer firms have run out of money than normally would have by now, and as a result, have not yet returned to the fundraising circuit. New York-based turnaround shop Monomoy Capital Partners, for example, has delayed fundraising for its second fund to focus on investing the rest of its first vehicle, a source familiar with the situation told Buyouts in November. Monomoy Capital closed its $280 million Monomoy Capital Partners LP in January 2007, above its $200 million target.
The disruption caused by the denominator effect, when falling stock prices increased the proportion of illiquid asset classes in LP portfolios, has diminished somewhat with the public equity market rally. But fundraising is still a struggle, said Dan Vene, a senior vice president with C.P. Eaton Partners, a Connecticut-based placement agency. “We still have two main culprits: nearly zero GP distributions back to LPs due to the extremely low volumes of transactions being completed; and managers seeking much more capital than is available.”
Indeed, consider Iowa Public Employees’ Retirement System, which allocates a maximum dollar amount that can be committed each year to private equity. In 2008, that cap was $800 million; in 2009 it was $500 million; in 2010, it will be $400 million. Consultant Pathway Capital Management and pension fund staff chose that amount based on the assumed investment and distribution pace of existing and future partnership investments.
To be sure, the very best investment managers can still raise capital, albeit at slightly more LP-favorable terms, but any first-time funds or second/third tier players “simply will not be successful in this market,” said Vene.
Recent examples of moves to appease LPs include The Carlyle Group agreeing to give LPs 80 percent of transactions fees charged to portfolio companies in its fifth fund, up from 65 percent. Other LP-friendly concessions seen lately include managers reducing fund sizes. Bain Capital offered LPs the ability to reduce their pledges to a $1.8 billion co-investment fund by up to 50 percent. And Sun Capital Partners in October offered to cut its Fund V to $5 billion from $6 billion. Permira Advisers, TPG and PAI Partners have also reduced funds sizes.
Closes this year—with the exception of distressed, turnaround and secondaries—have been elusive. “Investors are like kids in the proverbial candy store—they have more choices than they know what to do with—and are taking their time,” said Hussein Khalifa, a partner at New York and London-based placement agency MVision Private Equity Advisers. They are giving preference to funds likely to close in the short term and are looking for action from existing LPs, since there’s no upside to being the first to commit to a fund. “Pioneers get arrows and settlers get the land,” noted Khalifa. Also, LPs don’t feel any urgency to commit to the 2009 and 2010 vintages because funds pledged to in 2007 and 2008 have not yet deployed much capital. LPs will be getting exposure to deals done in 2009 and 2010 via the earlier funds, explained Khalifa.
LPs are also not rushing to pledge because they’re trying to gauge how much they need to set aside for re-ups—and are using this hiatus to cull their portfolios. “They’re deciding which relationships to keep and which to drop,” said Khalifa, because the difficult environment has led to a great performance disparity among GPs. “Some have clearly not performed well in a bear market and are not going to be supported the way they might have been. GPs are no longer getting automatic re-ups,” said Khalifa.
Yet a firm’s re-up rate can be a major factor driving potential new investors to commit. Thus GPs need to work in tandem with their largest LPs to move toward a close. “GPs must sit their returning LPs down and say, ‘We need to close by this date, so you need to speak to your fellow LPs’” to reassure them that the fund is indeed going to close, said Khalifa. “That’s now beginning to happen.”
Some Firms Still Getting It Done
As for the fortunate few who did get LPs to sign on to their funds, the most popular category by fund target size was the $1.1 billion to $5 billion group, which raised about $29.6 billion from LPs in 2009. The same group raised $98.1 billion in 2008.
Blackstone Real Estate Partners Europe III LP wrangled the most from supporters, having nabbed $4.4 billion by its June 2009 final close, bolting past its target of $3.5 billion. The opportunistic European real estate fund is designed capitalize on platform investing, public-to-private transactions, distressed situations, and corporate and government divestitures by investing in the United Kingdom and Continental Europe. The Pennsylvania Public School Employees’ Retirement System committed up to $285 million; March 2008 board documents noted that the firm’s prior funds are “on target to provide an investor-level aggregate IRR of 43.6 percent and an equity multiple of over 2.0x.”
Funds in the $300 million to $1 billion group gathered $15.5 billion during 2009, roughly half of 2008’s total of $29.1 billion. Supporters feel more secure about funds of this size when credit is scarce, since it’s easier for them to get financing for their deals. Oak Hill Advisors LP contributed an impressive chunk of the total for this category. The firm held the final close for OHA Strategic Credit Fund at $1.1 billion in September; the initial target was $750 million. The fund is earmarked for opportunities in stressed and distressed loans, bonds and other investments. The fund was launched in March 2008 and began investing in October 2008. The Arizona Public Safety Personnel Retirement System pledged up to $40 million in May, stating in board documents that Oak Hill Advisors looks at different areas along the credit spectrum and takes advantage of the best risk-adjusted returns for that time period.
In 2009, mega-funds of more than $5 billion captured only a fraction of what they raised in 2008, gathering a mere $12.8 billion versus the $89.9 billion of 2008, reflecting lack of interest in the strategy due to the shortage of debt financing for large deals. About two-thirds of what was raised came from one fund, Hellman & Friedman’s Capital Partners VII LP, which closed on Oct. 1 with $8.8 billion. In November, the California Public Employees’ Retirement System committed $300 million to the vehicle, which is earmarked for control-oriented buyouts of $300 million to $1.2 billion, mostly in the United States and Europe, in media services, professional services, information services and financial services companies. According to CalPERS board documents, the firm has achieved attractive returns through a variety of markets and economics cycles, earning top-quartile returns over an 18-year period, with a very low loss ratio.
The sub-$300 million funds brought up the rear with a mere $1.7 billion in commitments, less than half the $4.2 billion gathered in 2008, no doubt related to investors’ lack of confidence in new firms. The exception to the rule were usually firms that had headline names on the masthead. Solamere Founders Fund I LP led the pack with a $200 million gathering, hitting its target, although the fund is still open. Solamere Capital will invest the fund of funds in buyout, turnaround, growth equity, distressed, credit and venture capital funds. Taggart Romney, son of Bain Capital founder, former Massachusetts governor and 2008 presidential candidate Mitt Romney, is one of the founders. The Boston-based shop started to seek pledges for the investment vehicle in June 2008.
Distressed Was Strong
The big winners in the fundraising chase last year were distressed funds, which racked up about $9 billion in 2009, down from the $33.5 billion gathered for the approach in 2008. The distressed sub-sector really picked up steam in the final quarter of ’09, jumping from a total of $5.5 billion at the end of the third quarter to $9 billion by year’s end.
The trend was driven by the dramatic transformation in the credit markets; where once money was cheap and easy, it’s now almost unattainable. Thus, when debt-laden companies have problems, they may need investors to bail them out. Distressed debt shops acquire the debt of troubled companies for much less than its face value and then improve the company or trade the debt.
One such standout was Blackstone/GSO Capital Solutions Fund LP, a distressed debt fund designed to provide financial solutions to companies. It has raised $1.3 billion on a target of $2 billion, after a launch this spring. In May, the Teachers’ Retirement System of the State of Illinois provided a $100 million slug. The Blackstone/GSO Capital Solutions Fund is earmarked for leveraged loans, distressed investments, special situations, capital structure arbitrage, mezzanine securities and private equity. The firm will pursue companies that are overleveraged due to a failed LBO; misunderstood by the market; in a cyclical downturn; impacted by capital markets dislocation; undergoing litigation claims/lost market credibility; or are facing resolvable non-recurring issues/losses. Bennett Goodman, Tripp Smith and Doug Ostrover formed GSO in 2005. Before that, they worked for Donaldson, Lufkin & Jenrette, and then Credit Suisse.
Another favorite with LPs las year was Oaktree Capital Management’s OCM Opportunities Fund VIII LP. Launched in June, the vehicle has already accumulated $1 billion toward its $4 billion target. The Maine Public Employees Retirement System recently approved a pledge of $30 million, and the Washington State Investment Board recently committed up to $250 million. The Alaska Permanent Fund Corp., Massachusetts Pension Reserves Investment Management Board and the Montana Board of Investments are also supporters. Oaktree Capital will use the vehicle to invest globally in the distressed debt of large, overleveraged companies that are still operationally sound, using a distressed debt-trading strategy. The Los Angeles-based firm raised $10.9 billion for OCM Opportunities Fund VIIb LP, which closed in June 2008. Principals Howard Marks, Bruce Karsh, Richard Masson, Sheldon Stone, Larry Keele and Stephen Kaplan formed the shop in 1995.
Centerbridge Partners’s Centerbridge Special Credit Partners LP, launched in the first half of 2009, has so far raised $852 million toward its $2 billion goal. The firm focuses on distressed investments made to influence or control the restructuring of financially troubled companies. It seeks to maximize returns by controlling the restructuring to protect against future financial distress. The firm looks for good companies with bad balance sheets, especially LBOs with too much leverage. The Alameda County Employees Retirement Association pledged $35 million; Arizona Public Safety Personnel Retirement System committed up to $40 million; the Massachusetts Pension Reserves Investment Management Board committed $100 million; and Montana Board of Investments pledged $12.5 million. Centerbridge Capital I closed in 2006 with $3.2 billion. Jeff Aronson, former head of distressed securities investing at Angelo, Gordon & Co. and Mark Gallogly, former head of private equity at The Blackstone Group, founded the firm in 2006.