Cambridge: Glut of uncalled capital boosts prices

The industry has about $376bn of uncalled capital that was raised in the peak credit years, an overhang that is driving up prices and could expand as many firms are raising funds this year, according to Cambridge Associates.

The massive capital overhang – the glut of uncalled capital commitments in the private equity industry – has been chopped down from $425 billion as of the end of last year to around $376 billion as large funds found strong deal flow, according to new research from consultant Cambridge Associates.

The capital overhang topped out at $445 billion last year, generated by private equity firms having raised $915 billion from 2005 to 2010 and calling only a portion of that total. The total was reduced to about $425 billion last year, and by 31 December, about $376 billion remained uncalled, Cambridge said.

Large funds spent money on deals last year but raised little or no capital, which drove the reduction in the overhang, according to Andrea Auerbach, managing director and head of US private equity at Cambridge.

The reduction could be short-lived, however. With many mega-funds back in the market raising funds this year, and deal flow still much slower than in the heady days of 2005 through 2007, the overhang reduction will likely be reversed, she said.

The market this year is crowded with mega-firms trying to raise billions like The Blackstone Group, Kohlberg Kravis Roberts, Providence Equity Partners, Cerberus Capital Management, BC Partners and Apax Partners.

The overhang is too big. The overhang remains too large to be absorbed by anything other than a replay of the easy credit-powered transaction environment of 2005 through 2008.

Andrea Auerbach

A bulk of capital raised from 2004 to 2007 was meant to be spent on mega-sized deals and during that era, there were enough large deals to absorb the capital. Unfortunately, that era ended abruptly in 2008, leaving the outsized capital overhang. Deal flow has been building back up since last year, but nowhere near the frenetic levels during the peak credit years, Auerbach said.

Because there are not enough deals for the capital available, prices are going up as firms compete for quality assets, she said.

“The overhang is too big,” Auerbach told Private Equity International. “This is ‘use it or lose it’ capital, it has an expiration date … the overhang remains too large to be absorbed by anything other than a replay of the easy credit-powered transaction environment of 2005 through 2008.”

The largest portion of the overhang sits with large funds, Cambridge said. The overhang is concentrated in funds with more than $1 billion in commitments – 42 percent in funds of more than $5 billion and 43 percent in funds between $1 billion and $5 billion. More than 60 percent of the overhang is contained in the 2007 and 2008 vintages, which are only 46 percent and 34 percent called, respectively, Cambridge said.

Investors that committed into the overhang vintages and held off on commitments in 2009 and 2010 should see some benefit as the overhang capital went to work in the post-recessionary environment, Cambridge said.

“Commitments made to 2006, 2007 and 2008 vintage funds will offer exposure to current opportunities,” the firm said in a statement. “Investors that held back from new commitments in 2008 and 2009 – the vast majority – don’t need to worry about being ‘out of the market’ during what seems to have been a good buying period.

“As the overhang is put to work, these investors will get exposure to different market cycles without making


additional commitments to new funds,” the firm said.

Cambridge believes LPs’ best choice is to commit to funds under $1 billion that have specialised skills, rather than just mid-market generalists. The overhang for funds of sizes $1 billion or less is $56 billion. With hundreds of mid-market deals each year, the overhang should be easily absorbed, especially as mid-market deals have less access to financing than the bigger transactions.

“You have more supply, so there’s more opportunity to be competitive and find deals that showcase your talent as a manager,” Auerbach said.

However, LPs have to put in more work to scrutinise and analyse mid-market managers, especially as there are a lot more than large-cap managers, she said.