Private equity fund managers might have been sorry to see 1993 end, as a number of funds closed or neared their fund-raising targets last year, topping 1992's totals by almost 19%.
The private equity market started 1993 with the closing of the $1 billion Corsair Partnership from J.P. Morgan Securities Inc., although Corsair's first investment is in trouble. The market began the new year with a Jan. 14 closing of $1.3 billion for Morgan Stanley Capital Partners III.
Research by the Private Equity Analyst Newsletter, Wellesley, Mass., found private equity funds raised $12.7 billion in 1993. In 1992, $10.7 billion was raised. The number of funds also increased, to 105 in 1993 vs. 82 in 1992.
Funds that raised money in 1993 included: the $750 million Blackstone Capital Partners II; Freeman, Spogli & Co.'s $750 million FS Equity Partners III; the $500 million Boston Ventures Management L.P. IV; the $500 million Conseco Capital Partners II; and Castle Harlan Partners II L.P., with $255 million.
Among the funds expected to close in early 1994 are Morgan Stanley Capital Partners II and Hicks, Muse & Co. Inc.'s Equity Fund II, which will finish raising $500 million this spring.
The funds have targeted pension funds as investors. Many private equity managers say corporate pension funds are still leaders in the pension community when it comes to investing in private equity, although some public funds have entered the asset class.
The $17 billion Oregon Public Employes Retirement System, for example, has invested $1.6 billion in private equity.
With dampening expectations for equity, pension funds can make up some of that shortfall with high returns on private equity, said Stanley Pratt, general partner in Abbott Capital Management L.P., Needham, Mass. Mr. Pratt said he wouldn't be surprised to see funds that have had 3% to 5% invested in private equity increase their allocations up to 10% in the next two years, having already seen some funds increase to 7% in the past two years. "There's clearly a lot of money available for private equity in the pension community," said Frank Sica, managing director and vice chairman of Morgan Stanley Capital Partners III. "Private equity is becoming increasingly recognized as a valid asset category. People look more and more into portfolio diversification to achieve rates of return, so I'd say the climate is relatively good right now."
But while the allocations increase, some pension executives whose funds invested earlier are concerned that an influx of private equity funds could saturate the market and drive down returns in the future.
Webb Trammell, assistant treasurer of the Rockefeller Foundation, which has 7% of its $2.25 billion fund invested in private equity, compared the flow of funds to the onslaught into venture capital in the mid-1980s and the subsequent drag in its returns. "I'm concerned about the amount of money flowing in from big public funds. Even a small percentage (of their assets) is a large amount of money," he said.
In a saturated market, larger, better known companies will have the advantage in attracting capital.
"The market's matured, and people who don't have outstanding track records don't raise money in the current markets," said Thomas O. Hicks, chairman and chief executive officer of Hicks, Muse.
Buy-outs are still a popular investment. According to Private Equity Analyst, $5.51 billion of the capital raised in 1993 was in acquisition funds. But the focus has shifted from buy-outs of large, mature companies to investments in growth companies, often entrepreneurial efforts in the middle stages of development.
Private equity is moving from low-growth old-line manufacturing companies and into venture capital opportunities in high-growth industries that would see their returns diluted sharply by going into the public market for capital, say fund managers.
"Although we are seeing a significant number of investment buy-out opportunities, they tend to be somewhat smaller companies than they were a few years ago and therefore we don't see them hit the newspapers as they did back then," said Leonard Harlan, president of Castle Harlan Inc.
Two changes in the environment have altered the dynamics of private equity, said Robert Niehaus, managing director and vice chairman of Morgan Stanley Capital Partners III. A contraction in credit markets in 1990 made funds less available, which decreased significantly the size of the transactions. And, at the same time, the leveraged buy-outs in the 1980s left mature companies more leveraged, which made a 30% rate of return - the target for many large funds - much harder to achieve.
The comeback of the high-yield bond market will make the competition for good investment opportunities tougher, as companies go into the junk bond market to raise capital, said Morgan Stanley's Mr. Sica.
Junk bonds drive down returns among mature companies that have used them as growth capital in early stages.
Some funds are seeking to develop new opportunities, such as creating their own investments or investing overseas.
For example, Hicks Muse is building a broadcast group around a couple of radio stations in Sacramento, Calif., which it acquired for $48 million; Mr. Hicks said the company expects its worth to grow to several hundred million dollars with subsequent acquisitions.
In that area, the large funds have the advantage of wider research and analysis capabilities to help them identify potential areas of interest.
Mr. Sica said some private equity players may become involved in media transactions that are coming up next year, such as the Federal Communications Commission's auctions of frequencies.
Several large funds also are seeking to invest up to 25% of their assets overseas to take advantage of emerging markets and industry restructuring in countries with less developed capital markets.
The Corsair Partnership's first investment in August was the acquisition of 7.9% of Banco Espanol de Credito, Madrid, in a transaction worth approximately $160 million. Banesto since has been taken over by the Bank of Spain, however, and the fund's investment is in peril.
The economic climate in the United States has improved to an extent that companies may not need as much private capital, but that is not the case abroad, said Andrew Brown, a vice president with J.P. Morgan Securities Inc. Many countries are a few years behind in their economic cycles; problem assets are growing; and there may be investment opportunities there in the future, he said.
Marlene Givant Star also contributed to this story.