Remember overhang? That is private equity-speak for unused capital commitments. The recent flurry of unwound buyout deals has investors asking their managers whether overhang is coming back.
Private equitys halcyon days erased overhang from institutional investors vocabulary. Buyout investment managers were raising and spending capital as fast as they could to take advantage of the cheap debt and easy credit. Institutional investors were accommodating them, increasing their allocations.
Now, the tightening of the debt is taking the leverage out of leveraged buyout. Deals are failing, and jilted takeover targets are dragging their would-be buyers into court.
As a result, institutional investors have billions of dollars in uncalled commitments sitting on their books something that does not make them happy.
First, its an inefficient use of capital, said Mario Giannini, chief executive officer of private equity consultant and alternative investment manager Hamilton Lane, Bala Cynwyd, Pa. The limited partners have been paying fees on the full amount of the commitment and, if a smaller percentage than 100% is used, theres a fee drag.
Second, it wreaks havoc with institutional investors asset allocations, he explained. Limited partners have made commitments assuming the capital will be drawn, and their asset allocations are based on that, he said.
A slower investment pace combined with terminated megadeals could mean lower returns than investors and investment managers expected. The allocations will be invested in lower return-generating short-term instruments while investors wait for general partners to call.
I think that with both the deals that arent happening and the slowdown in the buyout markets, therell be more capital thats uncalled, Mr. Giannini said. The question for (limited partners) is whether that results in that capital never being called, either because that fund is no longer investing or because the (general partner) has already raised another fund.
These days, more buyout deals are being announced but not completed. In the U.S. alone, 20 large buyout deals worth $84.4 billion fell out of bed in 2007, compared with 20 large buyout deals amounting to $46.9 billion a year earlier, according to data provided by Dealogic LLC, New York. Globally, 83 deals worth $231 billion were withdrawn last year, double the year before.