Private Equity Spotlight May 2016 by Preqin
Distributions Drive Growth in
Using data from Preqin’s Private Equity Online database, Alastair Hannah examines the causes, effects and potential for future private equity distributions.
Warren Buffett: If You Own A Good Business, Keep It
In September 2014, Preqin examined the record distributions achieved by private equity firms in 2013 and discussed whether or not LPs would continue to receive such high distributions in the following years. Given the significant proportion of capital that was yet to be realized from pre-2008 vintages, high distributions were likely to continue if exit conditions remained favorable.
The latest data from Preqin’s Private Equity Online platform shows that full-year distributions in 2014 greatly exceeded the record levels achieved in 2013: $475bn was distributed ($294bn called) in 2014 compared with $329bn distributed ($217bn called) in 2013 (Fig. 1). Although net capital flows to LPs have been positive since 2011, the extent to which capital distributions exceeded capital calls reached unprecedented levels in 2014: annual distributions surpassed capital calls by 61%, compared with only 14% in 2012 and 52% in 2013. The latest data available, as at 30 June 2015, shows that $189bn was distributed from private equity fund managers to their LPs in the first half of 2015, compared with $117bn in capital calls, representing 40% of the total amount distributed in 2014.
During this time, aggregate exit value declined from $470bn in 2014 to $424bn in 2015. The fall in exit value from H2 2014 ($212bn), which yielded the record distributions, to H2 2015 ($193bn) suggests that the total capital distributed throughout 2015 could be less than the levels witnessed in 2014.
Net cash flows across geographies have not been linear over time, with North America-based funds calling up significantly more capital than was distributed to LPs in 2008: $241bn was called up and only $76bn distributed back (Fig. 2). Europe- and Asia-based funds distributed less capital in 2008 ($45bn and $9bn respectively) but also called up substantially less than their North America-based counterparts ($94bn and $41bn respectively). The result was a net cash fl ow away from LPs in 2008 for these regions (-$49bn and -$32bn respectively).
By 2010, the difference in net cash flow to LPs between regions had narrowed, with North America-based funds calling up $74bn more than was distributed back to LPs, while more capital fl owed into Europe- and Asia-based funds than in previous years ($69bn and $51bn respectively). Furthermore, North America-based funds were the first to deliver positive net cash flows to LPs in 2011 ($38bn), ending a period of called-up capital exceeding distributions across all regions from 2006. It was not until 2013 that Europe-based funds distributed more capital to investors than was called up, while LPs had to wait until 2014 for net cash flows from Asia-based funds to turn positive. This goes a long way to explain current LP appetite first to North America, then Europe, then Asia and emerging markets.
In line with the distribution of capital back from GPs, private equity fundraising has been growing steadily since 2010: aggregate capital raised increased annually from $171bn to a post-crisis peak of $336bn in 2014 (Fig. 3).
Regionally, North America-based fundraising has accounted for a growing proportion of private equity fundraising. The largest increases occurred from 2012 to 2013, when North America-based fundraising accounted for 52% and 60% of global aggregate capital raised respectively. In dollar terms, this represented a $71bn increase in aggregate capital raised, coinciding with the $75bn increase in cash distributed to LPs from North America-based funds. Contrastingly, Europe-based fundraising did not see such an increase in capital secured after Europe-based funds began generating net positive cash fl ow to LPs in 2013. Despite Asia-based funds distributing positive net cash fl ow for LPs in 2014 for the first year since 2001, Asia-based funds actually secured less capital in 2015 ($39bn) than in 2014 ($45bn).
With greater amounts of capital secured in recent years buoyed by the cash delivered to LPs, have private equity funds closed been more or less successful in their fundraising efforts?
In line with greater interest in the asset class from institutional investors, there has been a fall in the average time fund managers spend raising capital, from 20 months in market for funds closed in 2013 to 18.5 months in 2015 (Fig. 4). From 2012, buyout funds have, on average, secured capital faster than venture capital and growth funds. In 2015, buyout funds spent an average of 13 months on the road, compared with 19 months and 22 months for venture capital and growth funds respectively. This represents a substantial decrease in the average time that buyout fund managers spend marketing their funds, compared with 2013 (18 months). Regionally, North America-based funds, on average, have not seen a reduction in time spent in market post-2011, fluctuating around 17.3 months from 2012-2015 – this remains, however, the quickest average time for managers marketing vehicles.
Meanwhile, Europe- and Asia-based firms have spent less time marketing their funds since distributions exceeded capital calls, falling from approximately 20.4 months in 2013 to 19.1 months in 2015 for Europe-based funds, and from 20.2 months in 2014 to 18.6 months in 2015 for Asia-based vehicles.
Since distributions started exceeding capital calls, private equity funds have secured a greater proportion of their initial target sizes. In 2010, private equity funds on average were failing to secure their targets (achieving 91% of initial target size); by 2014, funds were generally more successful, securing 103% of their targets. This is supported across all regions, with the proportion of target size achieved by North America-based funds rising from 88% in 2010 to 107% in 2014; Europe-based funds’ rose from 87% in 2012 to 102% in 2014 and Asia-based funds secured 102% of their target in 2015, up from 89% in 2013.
Will Cash Continue to Flow to Investors?
When the Global Financial Crisis occurred, many private equity funds that bought assets at peak prices during the buyout boom were forced to hold onto investments due to poor exit conditions, causing distributions to LPs to shrink. In the years following the crisis, depressed pricing of companies provided opportunities for those private equity firms with capital to deploy. The exits of companies bought by these 2008-2010 vintage funds contributed to the record distributions witnessed over recent years. Interestingly, the majority of private equity-backed investments made as far back as 2009 have yet to be realized (Fig. 5), indicating the potential for further distributions, should favorable exit conditions allow these investments to be realized.
From 2014 to 2015, the average holding period for North America- and Europe-based portfolio companies fell from approximately 6.0 years to 5.6 years, an illustration of the favorable exit environment (Fig. 6). Data for 2016 so far shows a reverse of this trend for North America and Europe, with average holding periods returning to 6.0 years, while Asia and Rest of World have fallen from 5.3 to 4.4 years and 5.9 to 4.4 years, respectively.
Since 2009, there has been a reduction in the number of deals made for every exit; in 2009 there was one private equity-backed exit for every 3.2 deals, compared with 2.2 deals for every one exit in 2015 (Fig. 7). The reduction in the deal:exit ratio over time gives an indication of the more favorable exit environment seen of late; the same conditions that have put pressure on fund managers to find attractive entry prices for assets.
Appetite for private equity among investors has grown in recent years. According to interviews conducted by Preqin in December 2015 with over 100 LPs, 94% stated their private equity fund investments had met or exceeded their expectations in 2015, up from 81% in 2011. Record distributions back to LPs have played a large part in the satisfaction of investors in the asset class. With North America-based funds generating the highest net cash flows to LPs, it is perhaps unsurprising that this is reflected in institutional investor sentiment: 71% of respondents believed North America presented the best opportunities in the market, an increase of 11 percentage points from December 2014, and 37 percentage points from 2012 (Fig. 8). European private equity accounted for the second largest proportion in 2015: 49% of respondents viewed the region as presenting the best investment opportunities, albeit a slight reduction on the 52% seen in 2012 and 2013. Comparatively, only a fifth see Asia as presenting the best opportunities, down from 31% in 2013.
Private equity’s capability to deliver superior returns has driven investor interest, which is reflected in the volume of capital being raised by new funds and the average amount funds are securing at final close. With the majority of investments in 2009-2011 vintage funds still to be realized, there is potential for high distributions to continue, although this is dependent on favorable exit conditions continuing in the coming years. Moreover, although welcomed by LPs, record levels of capital back from GPs can present further challenges to investors, namely how and where to reinvest capital in order to maintain, or increase, their allocations to private equity. It will be the fund managers with the strongest track records in delivering high distributions that should benefit from LPs’ new investments.
Why Understanding the HOW of Private Equity Returns Is More Important than the HOW MUCH
– Prof. Oliver Gottschalg, Head of Research, PERACS
Private equity performance measurement is by design initially about the “how much” of value creation of a given fund manager. It is implicitly retrospective as today’s investors cannot “buy” a fund’s past returns but only commit to a manager’s future fund with the hope of obtaining high returns from this investment. For traditional performance measures (IRR and MOIC) however, a number of studies have shown that the past is not always the best indicator for future returns1. There are more advanced measures that provide a meaningful level of guidance to likely future outperformers2, but for most funds the granular level of cash fl ow data these require is simply unavailable.
The good news is that it is now possible to derive insight into a persistent value-creating ability for over 1,200 private equity funds through a novel benchmarking approach. This approach compares Preqin data on tens of thousands of underlying investments made by thousands of private equity funds to identify funds that are similar according to three different aspects:
(a) similar in the time period in which the fund was raised;
(b) similar in terms of when investments were made (based on acquisition years of the underlying deals); and
(c) similar in terms of which types of target companies were chosen.
By identifying the differences in average performance between these three groups we can isolate the contributors to relative fund performance into three distinctive decisions a GP makes: the Timing or the ‘When’, i.e. the decision of how investments were timed over the investment period of the fund; the Strategy or the ‘What’, i.e. the decision of which types of target companies were chosen (industry sector, size category, geography) to acquire at hose times; and finally the ‘Who’ and How decisions, which are really the “key ingredients” of implementation of the fund, i.e. the performance of the specific investment approaches within specific target companies, above the returns of other funds that made similar decisions in terms of timing and strategy. This typically encapsulates the best practice and operational insight applied by the GP within its portfolio and is the key differentiator when comparing private equity to other forms of asset management. An example of the results of this decomposition is illustrated in Fig. 1.
So what do investors gain from this new benchmarking approach? Well, it not only offers at least partial insights into the underlying skill-set of fund managers, but also enables one to explore whether and how the different performance components of the same fund manager persist or perish over time. To this end, we analyzed performance and deal activity data from Preqin on 1,253 funds, for which we observed a statistically significant3 level of positive performance persistence in the implementation skill component across the 257 fund pairs within the dataset4. Importantly, this component is also a significant driver of the overall multiple of the subsequent funds, whereas the simple TVPI of the0 prior fund (in line with prior academic work) fails to predict subsequent returns.
Now that we know implementation skill persists, the remaining question is then the “so what” for investors. In other words, how much better would a portfolio perform had the investor systematically committed to GPs whose prior funds indicated high levels of implementation skill-based returns. The results give investors a strong reason to consider the implementation skill measure for future fund commitments.
Had an investor picked 25 of the 257 funds, using only those with the highest previous implementation-based returns, the portfolio would have yielded 2.03x, which is significantly higher than if they had picked top performing funds by TVPI which returned only 1.73x. Even if the sample was extended to include the best 50 of the 257 funds by implementation returns, there would still be a meaningful performance improvement of 1.86x.
In summary, it is clear that traditional performance metrics are limited as an indicator of future outperformance. Working within the information limitations of private equity, the implementation skill component of fund returns, however, provides an effective way of identifying top performers in addition to providing valuable insight into the components of GP value add.
For more information on the methodology, detailed results and to see how this applies to your portfolio, please visit the PERACS website:
Preqin Industry News
2015 was the sixth consecutive year of increasing aggregate value of private equity-backed buyout deals in the information technology sector. Alastair Hannah takes a look at recent deals and fundraising in the sector, as well as recently closed vehicles.
Recent Private Equity-Backed Information Technology Deals
So far this year, the number of private equity-backed buyout deals in the information technology sector is on track to match 2015 levels, although the $37.6bn in aggregate deal value is only a quarter of the 2015 value. The largest transaction of 2016 so far occurred in February, when Apollo Global Management reached a definitive agreement to take ADT Security Services, Inc. private for $6.9bn in an all-cash transaction. After the transaction closes, Apollo will merge ADT with portfolio company Protection 1 in a deal valued at approximately $15bn.
Two more public-to-private transactions round up the largest three information technology deals of 2016 so far: the April acquisition of Cvent Inc. by Vista Equity Partners for $1.7bn and the $1.2bn acquisition of Norway-based Opera Software by an investor consortium consisting of Qihoo, Beijing Kunlun Tech Co., Ltd, Golden Brick Capital Management and Yonglian Investment.
Information Technology-Focused Buyout Funds in Market
There are currently 73 buyout funds in market globally, collectively seeking $103bn in institutional capital for investment in the information technology sector. San Francisco-based Vista Equity Partners’ sixth fund, Vista Equity Partners Fund VI, is targeting $8bn for small and mid cap investments in US-based technology and software companies. Strattam Capital, also based in San Francisco, is currently raising its inaugural fund, Strattam Capital Investment Fund. The buyout fund is seeking $350mn in institutional capital to target undervalued companies in the US in the business information technology market.
Recently Closed Buyout Funds Investing in Information Technology
So far in 2016, 12 buyout funds have closed that will target investments in information technology, securing an aggregate $12bn in institutional capital. In February 2016, Thoma Bravo Discover Fund held a final close on $1.1bn with the fund targeting US investment opportunities in mid-market software companies. Aquilline Financial Services Fund III held a final close in April 2016 on $1.1bn. Managed by New York-based Aquiline Capital Partners, the fund targets mid-market financial services investment opportunities, as well as global companies in the information technology industry.
In 2015, 575 private equity-backed buyout deals were announced in the information technology industry, valued at $136bn. Although the number of deals fell short of the 2014 fi gure (590), the aggregate value of deals nearly tripled compared with the previous year ($48bn).
Furthermore, the aggregate deal value in 2015 was the highest in the period 2006-2015 and represented over a third (32%) of the total value of all private equity-backed deals globally; this is the largest annual market share as a proportion of all private equity-backed buyout deals since 2006.
In Focus: India
We analyze the private equity & venture capital landscape in the second most populous country in the world using data from Preqin’s Private Equity Online.
In Focus: Venture Capital in the UK
Preqin explores the venture capital landscape in the UK, looking at funds closed, deals and investors using information from Private Equity Online.
With Ardian closing the largest ever secondaries fund this month, Andrew White analyzes historical and future fundraising, along with the firm types investing in secondaries vehicles.