With a team of only eight investment professionals, DuPont Capital Management’s private markets group, which manages funds of funds for the chemical maker’s pension and other investors, covers a lot of ground each year. The group looks at more than 300 general partners annually to distill down to an average of 10 commitments per year.
Carmen Gigliotti, managing director, said there are three hoops GPs must jump through to be considered for a pledge. The first is what he calls “value basis,” meaning managers must clearly define how they will achieve returns. The second hoop is a deconstruction of a GP’s track record to figure out if the way the firm achieved its returns is repeatable. Hoop number three is a demonstrated alignment of interest between GP and LP.
Since 1989, Delaware-based DuPont Capital Management, which has $20 billion of assets under management, has pledged north of $4 billion to more than 150 private equity funds. The funds of funds commit over a three-vintage-year period to managers whose strategies include domestic and international buyouts, distressed debt, mezzanine, special situations, co-investments, secondaries and venture capital. In 2006, DuPont Capital closed a fund of funds with $106 million, all of which is now committed.
The private markets group will likely pledge about $200 million over the next year, on par with its pace over the past year. Dupont Capital typically writes checks of $20 million to $30 million. Gigliotti finds smaller buyout funds of between $750 million and $1 billion especially attractive these days, and also has a liking for distressed investing, mezzanine funds and industry-focused vehicles. Of the eight to 15 pledges made annually, two to four each year usually go to new relationships, and one to two to emerging managers.
Buyouts has previously reported that DuPont Capital has supported mid-market lender Fifth Street Capital, mid-market buyout firms Marlin Equity Partners and The Sterling Group, and energy specialist Tenaska Capital Management LLC.
Ten percent of the assets DuPont Capital oversees come from third parties. Buyouts has learned they include the Anne Arundel County Retirement and Pension System, the Firefighters’ Retirement System of Louisiana, the Macomb County (Mich.) Employees Retirement System, Massachusetts Pension Reserves Investment Management Board, the New Bedford (Mass.) City Retirement System, the Nottinghamshire County Council Pension Plan and the pension fund of State Street Corp. Gigliotti declined comment on backers.
DuPont Capital has about half its private equity portfolio committed to buyout funds: 11 percent of the total is in small buyout funds of under $500 million; 22 percent is in medium-sized funds of less than $1 billion; 12 percent is in large buyout funds ($1 billion to $3 billion); and 5 percent is in mega-funds. In addition, 22 percent of the private equity portfolio is committed to special situation funds, such as royalty streams or distressed debt; 12 percent is pledged to venture capital; 4 percent to mezzanine; and the rest to a catch-all “other” category.
The Three Hoops
In investigating a firm’s “value basis,” DuPont Capital looks for opportunities where managers have clearly defined how they plan to achieve their returns, whether that’s an industry focus or buying companies in distress or turnarounds, for example.
What the value basis ultimately boils down to, Gigliotti said, is the belief that in the buyout space there is value in the lower end of the market, so his portfolio is significantly overweight toward small funds. Thus a buyout team doing smaller transactions is, in and of itself, a value proposition because he believes the negotiation for smaller deals is very inefficient. “If we are looking at two mangers, the one that can clearly demonstrate they purchase companies at good values and stick to the lower end of the market will get our capital,” he said. “They can’t overpay.”
DuPont Capital was very impressed with one particular group after finding it had an average purchase price multiple of 5x EBITDA, “which was a turn lower than what we were seeing at the time for mid-market buyout groups,” said Gigliotti. He was also impressed with this group because, even before its deals close, the firm works with family-owned companies to help them get new financial reporting and management information systems in place. The firm then professionalizes and builds management teams and identifies prospective add-ons.
The second hoop, manager qualifications, translates into ensuring the firm can execute on its strategy. The firm needs to have industry knowledge, technical expertise, operating experience and a clear ability to acquire and exit. “We spend a lot of time to make sure they have the capability to add value by doing a deconstruction of their track record,” said Gigliotti. This determines how much value the GP created through market improvements, how much through leverage and how much through multiple expansion.
“We try to understand what they were doing, and if can they repeat it,” said Gigliotti. For example, the track record deconstruction of one group DuPont Capital pledged showed that the firm bought at a low total enterprise value to EBITDA multiples (3.6x on average), that its portfolio companies had impressive average annual growth in revenue of 11.5 percent, EBITDA of 9.8 percent, and the firm employed moderate use of leverage, with debt to EBITDA at entry of 2.8x on average. This was the GP’s second fund, which was oversubscribed. DuPont Capital ended up committing $20 million to the fund.
Part of the second hoop involves verifying the managers are the ones who actually created the value, and that it wasn’t a club deal, where others did the heavy lifting. The DuPont Capital team checks that by talking to the investment professionals and the CEOs and CFOs of the underlying companies “and trying to understand who did what,” said Gigliotti. He also wants to make sure decisions are made by a team of perhaps three to five investment professionals, rather than by one main person. In addition, he likes groups that stay focused on their area of expertise rather than branching out and “just becoming an asset gatherer.”
The third hoop is alignment of interest. Gigliotti likes to see a meaningful investment by GPs into their funds, said Gigliotti, “It needs to be reasonable and significant to them. So if you’ve been in the business for a while and made a lot of money it should be significant dollars you’re putting in. If you’re still early in your life, and you’ve spent a lot of money building your firm, and you don’t have a lot of liquidity, yet you are putting a significant amount of your liquidity into it, that’s reasonable as well. It’s a balancing act,” he said. The GP that got the $20 million pledge from Gigliotti committed more than 10 percent of the capital in its fund.
Gigliotti also focuses on the fee structure of a fund. “Are they charging a reasonable management fee, are they charging transaction fees, and if so, where does that go, does it reduce management fees, is it credited to the funds?” Although there’s no absolute answer to the question of what is a fair transaction fee split, said Gigliotti, “We look at all fees, both historically and estimated going forward, and compare them to the current and or expected size of the team. If GPs feels they need to use transaction or portfolio monitoring fees to support their teams, we then decide if that is reasonable. At times, we have asked that these fees go directly to the staff and not to the partners, which they agreed to. This aligns us with the partners,” he said.