Fundraising environment is healthy but disconnected
Through the first six months of 2017, five private equity megafunds with USD5 billion or more in AUM did a final close, accumulating USD68 billion according to Pitchbook. Looking at the year in full, a report by McKinsey & Co found that of the USD750 billion in private market assets raised, US megafund buyouts accounted for 15 per cent; up from 7 per cent the previous year.
Overall, total assets raised by megafund buyouts rose 93 per cent to USD173.7 billion compared to middle-market buyouts, which attracted USD31.8 billion; up 7 per cent on the previous year.
These megafunds, operated by the biggest and highest pedigree management groups, have split the private equity industry asunder, with a small number of funds dominating the capital raising environment while the vast majority of small and mid-sized PE funds spend longer on the capital raising trail.
“As of July this year the Carlyle Group raised USD18.5 billion for its latest buyout fund, Lexington Partners have raised around USD12 billion, Ardian has raised USD12 billion for its Secondary VIII Fund so yes, it is clearly a trend we’ve seen over the last 18 to 24 months,” comments Emmanuel Raffner, Global Head of Private Equity & Infrastructure, Alter Domus.
According to Carlyle Group’s press announcement, its latest fund attracted more than 320 investors from 57 countries. That is a stark illustration of just how high in demand, across the globe, private equity has become.
The main driver behind inflows into megafunds, in Raffner’s view, is the large amount of net inflows LPs have been providing over the last three or four years from net distributions.
“Some managers have been unable to invest capital at the same pace as the amount of money coming in. But if you have a good relationship with a manager, you are happy with their track record, it’s probably an easier way for an LP to redeploy money faster and in a greater amount; and that is what these larger managers have experienced.
“Another driver for capital inflows has been the search for yield globally. If you are someone who is not used to deploying money in the PE space, you are most likely going to choose the more familiar names, the brand names. So there are two factors at play: large volumes of capital coming from existing LPs that need to be redeployed, and new investors who are seeking brand name managers in the search for yield,” opines Raffner.
The bifurcation in private equity is not only characterised by the capital raising imbalance between large and mid-sized managers, but also by the time being taken to reach final close. Brand name managers are raising capital in six months or less for their megafunds whereas the buyout space, more broadly, has spent 11 months on average raising capital compared to 19 months in 2010 and 13 months in 2007. Last year 921 funds closed, attracting a record USD453 billion in net inflows.
This year, says Raffner, there are 2,717 funds that are in the market fundraising. In January that number was 2,300 funds, according to Preqin.
“There are a lot of new funds in the market, a lot of new managers spending time on the road yet overall, we are seeing a decrease in the number of funds reaching a final close. At the same time, larger brand name managers are spending less time in the market reaching a final close.
“There is, consequently, a bit of disconnect in the marketplace – how will this be reconciled in the coming months given the amount of capital being deployed? That is the key question,” says Raffner.
In Europe, buyout activity in 2018 has been very buoyant. According to Aberdeen Standard Investments, in Q2 this year there were 58 UK transactions, the most since Q2 2008, while France was home to the highest volume of deals with 61; the most since Q2 2007.
Looking at figures for the first six months of 2018, France has maintained strong momentum with 63 buyouts worth EUR11 billion, up markedly from 51 deals worth EUR6.3 billion in H2 2017. This has been bolstered by seven of Europe’s 20 largest buyouts in the period, including HLD Europe’s acquisition of Kiloutou, France’s second largest industrial and construction equipment rental firm, for EUR1.5 billion from PAI Partners and Sagard.
“Coming back to my earlier point on new funds, we do see some first time managers with large amounts of capital commitments who have successfully fundraised fast and efficiently; for example, Novalpina Capital raised EUR1 billion for its first fund, which for a first time manager is a great success,” states Raffner.
The optics on fund raising are never black and white. There will always be some outliers in terms of new managers hitting the ground running but it remains true that overall, smaller and mid-sized managers have to compete more than ever with the pulling power of megafund managers.
“Over the last 12 months, especially in France, we’ve seen an increasing number of new managers starting with tens of millions of euros, some of them reaching EUR100 million, and the strategies they are developing are niche. They want to stand out and be differentiated in the market. If you send your fund prospectus to institutional investors, you have to be different. You can’t be the same as all the other buyout funds, for example.
“Investors work with managers with whom they have existing relationships while keeping the door open for new fund managers that catch their attention. Some tech-focused strategies are proving popular, for example, which focus their strategy on sub-sectors within technology: health tech, biotech, agritech.
“There is also a big trend in energy transitions, which are receiving a lot of support across various European governments. These are typically PE growth funds, targeting companies in the energy space that need financing,” observes Raffner.
Part of this interest in energy transition is in response to investors now wishing to seek out socially responsible investment opportunities.
“ESG is a big theme today,” says Raffner. “A recent investor report found that 80 per cent of investors viewed ESG as a key theme for the future. But the challenge for PE managers in Europe is how much capital can they actually deploy into ESG-related investments and projects that can make a difference to investors?”
This is especially true when one considers that in Europe, as in the US, valuation multiples in the marketplace continue to climb higher. As such, seeking out the right companies – in energy or any other industry sector – at the right price requires patience and deep analysis. If companies are uncovered that have a clear growth path, and also have good ESG credentials, so much the better.
On the current market conditions, Raffner concludes: “It is clear that GPs are having to pay higher amounts of capital for companies but if they are able to engage in pro-active support to management teams and create value by not only helping these companies reach new markets, launch new products, they can also explore other diverse ways of achieving that value creation. GPs are continuing to do this to make sure they do not fall off the valuation multiple cliff edge.”