Public markets fail to make the grade

Private equity achieved a record outperformance of listed equity in 2005 as Europe posted a 10 year IRR 3% better than the public markets.

In the US the results were even better, with American private equity returns outstripping the S&P 500 Index by 9%. These statistics are the fruit of the latest research by Strategic Capital Management (SCM), the Swiss fund-of-funds manager. The report said that the industry in both the US and Europe had its best year in 2005 for five years, with European buyouts topping the list.

Returns for the first half of this year bode well for the end of year figures, with a 25% increase in distributions compared to the opening six months of 2005, but there are signs according to SCM that pricing in both the buyout world and venture capital will continue to rise.

Stefan Hepp, CEO of SCM, said: “Investors are worried whether the recent surge of US$10bn plus buyout funds leads to excess capital in the market, but as the year 2006 progresses transactions like TDC in Denmark (€12bn), Philpps Semiconductor (€8.3bn), Pages Jaune (€3.3bn), the German chemicals company Brenntag (€ 3bn) or the attempted acquisition of the Hong Kong based Media firm PCCW (47.7bn) show that the trend towards larger deal sizes continues.”

The aggressive debt market is undoubtedly one of the drivers behind this drift to bigger and bigger deals, and is also the reason why there were so many distributions by funds in the first half of 2006. Hepp says: “Deals done during 2002-04 often had a low leverage by historical standards and rather tight covenants. The abundant supply of debt financing with loose covenants and low coupons in 2005 has thus created an almost ‘once in a lifetime’ opportunity to recapitalize deals as it allowed funds to repay lots of capital to their investors without unduly increasing the financing risk of their portfolio companies. 2005 may, however, have been the crest of this wave and we expect fewer distributions coming from recapitalizations in 2006.”

On the topic of fundraising, SCM confirms what everyone already knew, that 2005 was a great year if you were a private equity firm looking to raise a fund. Global fundraising reached a record high with around €172bn flowing into the coffers of PE managers.

The big guns were the main beneficiaries of this flight to private equity, with 65% of the capital raised in Europe ending up in the hands of the mega-buyout funds, i.e. those with funds larger than €1.9bn. In the US the figure was 60%. The 15 largest firms by total assets under management accounted for 36% of all capital raised in 2005 globally.

“Looking at the closing sizes of new funds raised by the 15 largest private equity managers in 2005, these managers collectively added US$83bn (€62bn) to their war chest, which again suggests that the quest for larger deal sizes will continue. Indeed, M&A volumes (announced deals) have increased by 14% during 1H 06 over the same period in 2005. However, despite record fund sizes one needs to put the growth of the industry into perspective. The capital raised by the 15 largest firms in 1H 05-1H 06 still amounts to just 0.7% of the capitalization of the S&P 500,” says the report.

Investments reached a volume of €81bn in 2005, a significant increase on previous years, which SCM credits to the strong growth of European investment activity, which saw a record transaction volume of about €36bn.