A year after the financial crisis subsided, the $2.5 trillion private equity (PE) industry is finding the easy money may be gone.
Managers saddled with $1.6 trillion in buyouts made during a three-year boom have marked at least six of the era’s 10 biggest deals at or below cost. About $470 billion sits idle, according to London-based researcher Preqin. Announced purchases so far this year total less than a fifth of their volume at the peak in 2007.
Pensions, endowments and mutual funds cut new commitments to buyout funds by more than 50 per cent, according to Preqin, questioning whether firms led by Blackstone Group LP have grown too large to generate the returns that made their founders billionaires. Blackstone, the world’s biggest private-equity company, has dropped 67 per cent in New York trading since a 2007 offering, and Fortress Investment Group LLC lost 82 per cent. KKR & Co. this month cancelled a $500 million stock sale.
“There is a rightsizing of the industry right now,” said Joncarlo Mark, senior portfolio manager at the California Public Employees’ Retirement System, the largest state-run U.S. public pension. “A lot of investors have limited ability to commit new capital, and it’s going to stay that way for years unless public markets come back in a meaningful way.”
Calpers slashed its commitments to 2009 funds by 90 per cent from those made to 2008 funds — to $1.27 billion from $12.7 billion — according to data compiled from the pension’s website. It committed a record $15.1 billion to 2007 funds.
Overall, private-equity funds raised $281 billion last year, a 57 per cent drop from the record $646 billion collected in 2007, according to Preqin.
Rates of return
Private-equity firms, which have their roots in the leveraged buyouts of the 1980s, pool money from investors to take over companies, usually with a mix of cash and debt, with the intention of selling them later for a profit.
The firms grew into multibillion-dollar asset managers, helped by returns that dwarfed what investors could earn in traditional assets such as stocks and bonds. Funds with more than $2 billion in commitments that were completed in 2001 and 2002 generated median rates of return of 34 per cent and 33 per cent, according to Preqin.
Institutional investors including endowments and pensions poured money into the funds as limited partners, committing more than $200 billion in a single quarter at the height of the buyout boom. The fund managers, or general partners, collected management fees of 2 per cent of the capital committed and 20 per cent of profits, making buyout pioneers including Blackstone’s Stephen A Schwarzman and KKR’s Henry Kravis and George Roberts billionaires.
‘Pumped out profits’
“From 2005 to 2008, firms pumped out profits in 24 hours, buying on Monday and selling on Tuesday,” said Antoine Drean, head of Triago SA in Paris, which helps firms raise money. “That made for fundraising that was like a lottery, in which every ticket was a winner. That was too good to be true.”
The “lazy” days of easy fundraising are over, Tony James, president of New York-based Blackstone, said in an interview. Last month the 59-year-old Wall Street veteran flew across the country to win a commitment from the Oregon Investment Council to invest in a new $13.5 billion buyout fund. Instead of jumping at the opportunity, the council’s members grilled James for almost an hour about the performance of Blackstone’s 2007 fund, its fifth buyout pool.
The Oregon pension committed $1.6 billion to private-equity funds last year, down from $2.7 billion in 2008, according to the state treasury.
Blackstone Fund V
“That all sounds really great, and you probably raised money at the right time so you could go out and get deals,” Katherine Durant, who helps oversee $52 billion for state employees as a member of the council, said during James’s presentation in the Portland suburb of Tigard, which was open to the public. “That said, why does Fund V look so bad?”
Blackstone Capital Partners V was valued at a loss of two per cent including fees, compared with a seven per cent drop in the Standard & Poor’s 500 Index during the same period, James told council members seated around him in a semicircle. He said it would return investors twice their money eventually.
The firm’s 1994 fund delivered 2.2 times investors’ money and average annual returns of 37 per cent, according to Calpers, one of the investors.
Below cost
Blackstone’s Fund V isn’t the only pool started in the boom years that’s struggling. As of the end of the second quarter, New York-based Fortress had $4.9 billion in unrealized, or paper, losses from private-equity funds started since 2005.
That’s because at least six of the 10 largest buyouts announced between 2005 and 2007 are marked at or below cost, according to public disclosures and communications with investors obtained by Bloomberg. KKR and TPG Capital’s Energy Future Holdings Corp; Blackstone’s Hilton Worldwide; and Apollo Global Management LLC and TPG’s Harrah’s Entertainment Inc. have all sought to restructure their debt through methods such as debt exchanges or additional equity infusions.
Energy Future Holdings, the Dallas-based power producer formerly known as TXU, was the largest leveraged buyout in history when it was announced in 2007, with a value of $43.2 billion. At the end of the second quarter, KKR valued the company at 30 cents on the dollar.
