Hope springs eternal, and this season buyout G.P.s are feeling optimistic. After a record $55.4 billion was raised last year by buyout firms, one would imagine the jets would cool slightly in 1999.
However, in the first quarter, 25 buyout firms launched funds seeking more than $14 billion. While this mark falls short of the $18.8 billion G.P.s came to market with in the first quarter of last year, sources say buyout groups just might give 1998’s fund-raising totals a run for their money should the trend of LBO funds greatly exceeding their targets continue.
G.P.s already are off to a fast start, having raised nearly $8.6 billion in the first quarter. This total is greater than any prior first quarter and approximately 28% more than the total raised in the first three months of 1998.
However, many sources are looking at the numbers and predicting G.P.s still will raise less capital in 1999 as L.P.s become more cautious in private equity investing.
“The numbers could increase, but I just think it is becoming less of a probability. I think the number of quality firms can’t continue to come out. Most of the L.P.s I talk to view the quality and quantity equation as being much weaker than last year,” says John McLaren, a placement agent at the Monument Group.
The question that buyout firms must now face, sources say, is “How large is the appetite for funds?” G.P.s continue to launch more vehicles and will keep doing so until supply meets demand; meanwhile, L.P.s have been on a feeding frenzy since the summer of 1996.
This mix is why buyout firms raising funds this year may find L.P.s becoming more cautious when investing in private equity.
“There’s a fair amount of people looking at what happened last year and asking themselves if they invested too much,” says a G.P. who is presently raising a billion-dollar fund, and who declined to comment for the record. “What I hear from L.P.s is, we committed a lot of money last year, and we need to rework our math, so we need to be cautious,” the G.P. says.
After a Record Year, Some L.P.s Recoil
The record amount of capital raised in 199862% more than 1997’s total-may now be giving L.P.s some pause, sources say. One example is Connecticut State Employees’ Retirement Fund, which has decided to pare back some of the commitments it made to buyout funds last year so as not to exceed its allocation.
The class of 1998 saw numerous brand-name groups come to market, including headliners Apollo Advisors, L.P., Bain Capital, Hicks, Muse, Tate & Furst Inc., Thomas H. Lee Co., E.M. Warburg, Pincus & Co. LLC and Welsh, Carson, Anderson & Stowe. Most sources consider this a more attractive lot than the firms looking to raise capital this year, including The Carlyle Group, Hellman & Friedman Plc, Madison Dearborn Partners and Vestar Capital Partners.
Predictions aside, there now is more competition for L.P. capital than ever before, thereby making it more difficult for buyout funds to reach their targets.
L.P.s, even those that are intent on committing large amounts of capital, can afford to be choosy.
“I think there is a lot of money chasing deals, and that is why I want to be cautious,” says Donna Anderson, chief investment officer at the New York City Retirement Systems, which is committing $2 billion to private equity in the next several years (see story, p. 5). She says being cautious means committing capital only to groups that have partners with experience making investments together.
In all, there now are about 100 firms in the marketplace raising buyout funds. Of the 78 funds launched in 1998, firms have wrapped only 28% of those vehicles, according to BUYOUTS. Also, many of the G.P.s that launched last year saw delays in the late summer and fall when the stock market tumbled and L.P.s stopped making commitments.
Two groups that launched large funds last summer-Marsh & McLennan Risk Capital Corp. offered the $1.5 billion Trident II, and American Industrial Partners launched the $850 million American Industrial Partners Fund III, L.P. (BUYOUTS Aug. 17, 1998, pp. 1,6)-were impacted by the falling stock market and had difficulty generating interest, industry sources say. To date, neither firm has held a first closing.
“I feel for the sponsors, I really do,” says Attila Koc, a senior vice president in the leveraged finance sponsors group at Credit Lyonnais. “I especially feel for the first-time funds. There’s never been a more competitive time to raise money.”
Only three of the 30 firms that launched debut funds in 1998 have wrapped their efforts, according to BUYOUTS.
To stand out in a competitive environment, G.P.s are making claims to niches they say will allow them to find deal flow. Several G.P.s and placement agents say showing a good track record of solid returns may not be enough anymore to convince L.P.s of a fund’s worth.
G.P.s Need More Than a Track Record
“I think people like me need to be better prepared to tell a story,” says Robert McGroarty, a placement agent at RGM Financial Marketing, referring to today’s necessity of showing perspective limited partners something more than historically strong internal rates of return. “Now, we have to be a bit more sophisticated, where before, we could depend on pent-up demand.”
The three firms that have raised the most capital in 1999 all have had interesting stories to tell. Madison Dearborn Partners, which closed on all of the $2.22 billion it raised for Madison Dearborn Capital Partners III, L.P. in the first quarter (see story, p. 8), claimed it needed to raise capital partly to fund larger deals it is finding in the natural resources industry. Vestar, which currently is readying a $2 billion fund, is using a similar pitch after having added former Energy Secretary Federico Pena as a senior adviser last year (BUYOUTS July 20, 1998, p. 4).
Robert Bass-backed Oak Hill Investors, meanwhile, is selling Oak Hill Capital Partners, L.P. as the first buyout fund that will tap the contacts Mr. Bass has gained through more than 15 years of private equity investing (BUYOUTS Oct. 12, 1998, p. 1). The firm held closings in the first quarter totaling $1.55 billion.
Questor Management Co., which raised the $800 million Questor Partners Fund II, L.P. last quarter (BUYOUTS Feb. 8, p. 6), also has a story that differs from what other G.P.s tell. The group targets controlling interests in underperforming or distressed companies and often works with Jay Alix & Associates, a consulting group that specializes in turning around companies. This appeal was evidently more important to its investors than the personnel turnover that occurred last year at the firm. Two of Questor’s four principals left the group last year before it launched Fund II (BUYOUTS July 20, 1998, p. 6).
L.P.s are also taking different approaches to investing this year, sources say, as many of the well-entrenched buyout firms are not raising domestic funds.
Several L.P.s-such as California Public Employees’ Retirement System and Washington State Investment Board-are looking to start new relationships with G.P.s raising midsize funds, while other limiteds this year are targeting commitments to familiar firms raising unfamiliar vehicles.
In either case, groups raising funds are emulating the approach of the groups that have met with success this year by trying to differentiate themselves from the crowd.
For example, Silver Lake Partners LLC last quarter launched a $1 billion buyout fund to invest in subsidiaries of publicly traded technology companies (BUYOUTS Feb. 8, p. 1). Silver Lake could be the first of several firms to tap investor interest in that sector, sources say.
“It appears the technology sector will spawn several funds, because we all know what technology stocks have done in the public markets,” says Jay Fewel, the director of equity investing at Oregon State Treasury. Thomas Weisel Partners is raising a $500 million fund that also will have technology as a focus (BUYOUTS Feb. 8, p. 3), and Broadview Associates is raising a $150 million fund to buy later-stage companies in the technology sector (BUYOUTS Feb. 22, p. 12).
A strategy that also may pick up steam, but stands out for now, is raising capital to target minority stakes in public companies. Gilbert Lamphere, the former co-head of Fremont Partners, currently is readying a $500 million fund to invest in undervalued small-cap stocks (see story, p. 3). Firms ranging from Charterhouse Group International to Thomas H. Lee Co. now are making many of their investments by taking minority stakes in public companies.
Then there are the operations managers who believe they can access unique deal flow and catch a gleam of Bain Capital’s lightning in a bottle. For example, The George Group, a Dallas-based consultant, has started shopping a $500 million buyout fund to invest in manufacturing companies that are not run at maximum efficiency (BUYOUTS March 8, p. 16).
Meanwhile, NorthCastle Partners has entered into a partnership with consultant Bain & Co., allowing the firms to share deal flow.
Partnering with Larger LBO Buddies
Several firms that have more modest targets and track records are succeeding by partnering with larger LBO shops, thereby gaining instant credibility.
Gryphon Investors is raising capital from partners at Kohlberg Kravis Roberts & Co., Oak Hill Capital Partners and Texas Pacific Group as anchor L.P.s (BUYOUTS Jan. 25, p. 1). Halifax Capital Partners also is partnering with TPG’s David Bonderman to raise a $250 million buyout fund that will invest in companies impacted by cyclicality or regulatory changes (BUYOUTS Dec. 7, 1998, p. 6).
Buyout Industry Goes Global
From the pool of blue-chip buyout firms that raised domestic funds in the last 18 months, several groups now are raising non-traditional partnerships.
“It is our view that private equity firms as moms and pops don’t create value, but if you develop a family of funds you have the nucleus of a real franchise,” says David Rubenstein, founder of The Carlyle Group, which is now raising a collateralized bond obligation fund, an Asian fund and, later this year, will raise a new U.S.-focused buyout fund.
The most popular destination for established firms with new offerings is Europe, as G.P.s see cross-border opportunities resulting from the continent’s new single currency.
KKR is raising a $2.5 billion fund for Europe and has attracted a $400 million commitment from Washington State Investment Board (BUYOUTS Jan. 25, p. 6), as well as a $300 million commitment from Oregon State Treasury. Hicks Muse also is raising a $1.5 billion Europe fund.
At the same time, several firms are marketing funds targeting buyouts in Asia, sensing the region, and L.P. appetite, soon will bounce back. In addition to Carlyle, heavyweight Chase Capital Partners has launched a fund with a target in excess of $750 million that will pursue control investments in Asia (see story, p. 1).
Some firms that focus on growth financings are raising capital through mezzanine funds. Thomas H. Lee Co. now is marketing a $1 billion effort (BUYOUTS Jan. 25, p. 1), while GTCR Golder Rauner LLC is looking to round up $400 million for a mezzanine fund that only will invest alongside the buyout firm (BUYOUTS Feb. 8, p. 4).
“I do think that there are many investors who would rather invest with firms in which they have a long-standing relationship than with a group in which they have no prior relationship,” says Scott Sperling, a partner at Thomas H. Lee Co., explaining why there are several groups that are starting to raise families of funds.
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