DALLAS The $45 billion leveraged buyout of TXU Corp. led by TPG and KKR could leave some institutional investors double- and triple-exposed to the massive deal.
Last week, TXU, the largest electric utility in Texas, announced that a group of investors would buy the company for $69.25 per share.
Among the pension funds that have made commitments to both TPG Partners V (Texas Pacifics latest fund) and KKR 2006 (Kohlberg Kravis latest) are the $236.6 billion California Public Employees Retirement System and the $157.8 billion California State Teachers Retirement System, both in Sacramento; $72.9 billion Washington State Investment Board, Olympia; Oregon Investment Council, which oversees the $60 billion Oregon Public Employees Retirement Fund, Salem; and $30 billion Pennsylvania State Employees Retirement System, Harrisburg.
I expect that many of the largest funds are invested in both KKR and TPG and so (will) have exposure in TXU, if it happens, through both investments, said Mario Giannini, chief executive officer of private equity consultant and alternative investment manager Hamilton Lane, Bala Cynwyd, Pa. Endowments and foundations may not. They have traditionally not been big players in the large buyout space.
In addition to investing in one or more of the buyout funds, institutional investors again, mainly public pension plans that have large uninvested private equity allocations could find themselves involved in two other ways:
- They could participate in the deal directly, as co-investors with one of the buyout firms or through co-investment funds, often sponsored by banks.
- And down the road, some of those investors might also get an equity piece of the company by taking over some of the equity bridge financing. In bridge financing, investment banks provide some of the equity that buyout firms need to close a deal, but its short term, lasting 45 days to several months. Then, buyout firms usually get their limited partners to buy the banks piece. If the buyout firm does not buy back the banks interest in time, the bank will generally sell its equity positions. Buyout firms need the co-investment and equity bridge financing to limit the percentage of a fund invested in a single deal.
The main issue for private equity investors is lack of diversification, said Stephen Nesbitt, chief executive officer at alternative investments consultant Cliffwater LLC, Marina del Rey, Calif. You expect to get diversification from investing in three disparate buyout funds, and youre triple-exposed.
The $37.6 billion Los Angeles County Employees Retirement Association, Pasadena, has commitments to TPGs fund and to Morgan Stanleys private equity co-investment fund.
Co-investment has become a popular way of investing in private equity for some large public pension funds.
In a co-investment, investors can get part of the deal at a much reduced cost, said Mr. Nesbitt. Public funds are under-allocated to their targets and have the capacity to invest outside the sponsored limited partnership.
CalSTRS co-invests on private equity deals, but Réal Desrochers, director of alternative investments, wouldnt say how much the fund has put into co-investments.
It would be possible for CalSTRS to have double or triple exposure to the same deal in its private equity portfolio, which is a concern, he acknowledged. But, he added, We always measure our exposure.
Co-invest or buy up?
Time will tell which investors will co-invest or buy up equity bridge stakes in TXU, and how much TXU exposure will end up in their private equity portfolios.
We have the ability to co-invest in the TXU and/or other buyouts, but staff has no idea at this point on any TXU plans, said Clark McKinley, CalPERS information officer.
Generally, CalPERS has co-investment options alongside its general partners on deals, Mr. McKinley said. When evaluating any potential co-investment, we would look at the security that was being offered and how it would fit into our current portfolio, including how much exposure we would have to any single deal, Mr. McKinley said.
Oregon Investment Council officials would not be interested in co-investing or buying a piece of the equity bridge with either TPG or KKR because of the size of its potential exposure to TXU through investing in the funds alone, said Jay Fewel, director of investments. The council has $300 million invested in TPG and $1.5 billion in KKR 2006.
So, if TXU comes to fruition, Oregons current commitment will already be a big stake, Mr. Fewel said. You cant have too much of a good deal, and you cant have too little of a bad deal, Mr. Fewel quipped.
Equity bridge financing and co-investments dont necessarily cause overexposure to deals, Hamilton Lanes Mr. Giannini said.
Some institutions will get additional exposure through co-investment. For many, however, the aggregate amount of exposure will be a factor in whether they make any offered co-investment, so they will normally be well aware of that, he said.
However, co-investment fund investors do not have the ability to modulate their exposure, Mr. Nesbitt noted; as with other private equity funds, the commitment is made in advance.