Private equity firms might have a hard time spending the treasure-trove of capital they've raised recently if the supply of large deals does not pick up soon, industry insiders say.
In January, New York-based private equity giant Apollo Global Management closed an $18.4 billion flagship fund, the largest buyout fund raised since the 2008 recession. In 2013, Blackstone Group closed its $15 billion fund, while Carlyle Group closed its sixth U.S. buyout fund with $13 billion.
But that fundraising success might not be an advantage.
While the number of deals made by buyout funds rose in 2013 to near pre-crisis levels, sizes of the deals were smaller, according London-based alternative investment research firm Preqin. As in 2012, most deals made in 2013 — 57% — were valued at less than $100 million.
The result is that private equity firms might have trouble spending the estimated $500 million or so per transaction that comes with raising multibillion-dollar funds, industry insiders say. Just 6% of the global private equity transactions in 2013 were valued at $1 billion or more, down from 7% of total private equity transactions in 2012, according to Preqin.
With stock prices high, companies have little incentive to sell business units, a prime source of large private equity transactions, said Susan Long McAndrews, partner in the San Francisco office of Pantheon Ventures.
“I've heard from managers that there is a lack of urgency to sell (among corporations) because if they sell a business they have to redeploy capital for shareholders,” she said.
While she doesn't expect corporations to start selling units any time soon, Andrea Auerbach, managing director and head of private growth research in the Menlo Park, Calif.-office of consulting firm| Cambridge Associates LLC, said it is possible very large deals might be coming back. The money spent on deals that were $2.5 billion or larger more than doubled last year to $73.2 billion from $34.1 billion in 2012, according to a Cambridge analysis of Dealogic data.
However, the 2013 data might be skewed a bit by a few large deals, including Dell Inc. Cambridge executives have been watching for the return of very large deals because it could signal a movement toward the next market top in private equity.
David Druley, a managing director at consulting firm Cambridge in Boston, and CIO of the team that manages discretionary pension money, said that in 2007, private equity firms spent $770 billion making deals. By the end of November 2013, private equity firms had spent $310 billion.
Fewer deals and capital spent combined with robust fundraising “could have (general partners) trying to outspend each other,” Mr. Druley said. “I think 2014 will be a pretty robust fundraising year due to who is going to be in the market.”
Strong equity returns last year pushed most private equity allocations below target, he noted. Investors also are getting more money back in distributions than having capital called by current private equity funds, Mr. Druley said. “That creates a challenge for investors,” he said.
In many cases, investors are trying to commit more capital either because they are underweight in private equity or are increasing their targets, Mr. Druley said.
Investor sentiment for private equity is very strong; most investors are maintaining or increasing both short- and long-term allocations, according to the results of a Preqin survey. Nearly 70% of investors surveyed by Preqin in December said they intend to make their next commitment to private equity funds in the first half of 2014.
And an increasing amount of capital is landing in the coffers of the largest managers. In 2013, nearly half the total capital raised worldwide went to only the largest 5% of private equity funds, according to Preqin's most recent private equity report also released last month.
Assets under management and dry powder — uncalled capital commitments —have continued to grow. Assets reached a record $3.5 trillion as of June 30; dry powder grew to $1 trillion as of that date, vs. $941 billion a year earlier, according to Preqin.
“The dry powder numbers get inflated by the private equity firms that raised way too much capital, because they were successful and there was demand for a fund that can't be deployed,” Ms. Long McAndrews said. At the same time, there are private equity firms that are at the tail end of spending the capital they raised during the pre-crisis bubble times, she said.
Examples of older funds that are still being tapped include TPG Capital LP's TPG Partners Fund VI LP, a $19 billion fund closed in 2008. Last year, investors extended the fund's investment period by a year to February 2015. TPG is raising a new distressed debt fund, TPG Opportunities Partners III, a $2 billion sidecar to thatfund. TPG also is raising an interim fund, aiming to raise $1.6 billion to $2 billion from select investors for bridge capital between the expiration of TPG Partners Fund VI and its next buyout fund, TPG Partners Fund VII, which TPG plans to start raising late this year or early in 2015, according to materials released for the Jan. 29 Oregon Investment Council meeting.
With all the money being used to fund smaller deals, large private equity managers will then need to migrate down to the midmarket, making those deals more competitive and pricier, said Jeff Bunder, global private equity leader in the New York office of Ernst & Young LLP. “Bigger funds are clearly focused on those larger deals” but competition could also be mounting for deals in the $1 billion range, he said.
“You could have twice the number (of bidders) than for a larger deal,” Mr. Bunder said. “Bigger funds drop down, middle-market firms size up, and all of sudden you have a whole lot of funds chasing the same asset,” he said.
Private equity firms could also resort to buying companies from other private equity firms. Both scenarios are indicators of lower private equity returns to come, observers say.
“In my opinion the key factor is the firm's strategy. It is important to have a strategy and to follow it and the firms that are consistent with their strategy have the ability to source deals,” said Craig A. Bondy, managing director of GTCR, Chicago in an interview. Last week, GTCR closed its 11th buyout fund, GTCR Fund XI, with $3.85 billion, above its $3.25 billion fundraising target.
Mr. Bondy expects to see deals between private equity firms because so many large businesses are private equity-owned already, he said.
Still, he acknowledged that so called corporate carve-outs, industry lingo for sales of business units by companies, are rare lately. Instead, he has seen more deals from other avenues.
“Right now we are seeing more founder-created businesses in our portfolio” than business units purchased from large companies, Mr. Bondy said.