Debt to the rescue

TPG’s buyout business is battling to turn around two flagship funds. Meanwhile, a canny decision to develop its credit business is bearing fruit.

TPG Capital is facing a challenge: its crisis-era buyout funds have so far disappointed. Fund VI, which closed on $18.87 billion in 2008, was netting an 8 percent internal rate of return as of 30 June last year. Its $15.37 billion 2006 vintage has fared worse, thanks largely to debilitating market shifts that occurred shortly after its heavily leveraged buyouts of Harrah’s (now Caesars Entertainment) and Energy Future Holdings. Fund V was generating a negative net IRR as of the same date, according to The California Public Employees’ Retirement System.

As such, the firm’s traditional buyout business has been forced to adapt. TPG undertook a “back-to-basics” initiative in 2009, opting to focus on smaller transactions rather than heavily leveraged big buyouts, according to Oregon Investment Council documents.

It has also applied a similar ‘back-to-basics’ approach to its fundraising efforts for private equity. TPG is currently marketing a $1.6 billion fund to serve as bridge vehicle between the conclusion of Fund VI’s investment period and the launch of Fund VII, according to Oregon documents. This could enable TPG’s buyout team to generate some much-needed momentum as a lead-in to the marketing of Fund VII, which is scheduled to kick-off in late 2014 or early 2015 with a reported target of $10 billion.

It’s an unconventional tactic, to be sure, and indicative of how discriminatory limited partners have become with regard to disappointing returns – even from the most prominent of buyout firms.

Fortunately for TPG, its future is not solely contingent on the success of its buyout funds. Because as we speak, the firm is racking up wins through its credit and distressed business.

Around the same time that its buyouts platform implemented the ‘back-to-basics’ initiative, TPG hired Alan Waxman and other senior executives from Goldman Sachs to launch a special situations business. The new team – dubbed ‘TPG Opportunities Partners’ – quickly set about building its portfolio through the firm’s private equity business and launching a pair of funds – TPG Opportunities Partners II and TPG Specialty Lending – shortly afterwards.

The results have been nothing short of outstanding.

“Since inception, the TOP funds have generated gross IRRs in excess of 30 percent and net IRRs in excess of 20 percent,” Oregon Investment Council wrote in a memo released on 29 January. “Moreover, previous side car investments have enjoyed similar returns.”

The team’s success has manifested itself on the fundraising trail as well. The firm is expected to hold a final close on the oversubscribed TPG Opportunities III – targeting $2.6 billion with a $3 billion hard-cap – at some point this month. Furthermore, the Special Situations platform is poised to secure a separately managed account with New Jersey Division of Investment (which adds $200 million and combines a pair $100 million accounts the firm already has with the state), and Oregon recently announced a $250 million commitment to an Opportunities Partners sidecar vehicle.

The sidecar vehicle and separate account will likely pursue opportunities outside the platform’s traditional mandates, including distressed asset sales from commercial banks, medical royalties, re-performing real estate loans and mortgage servicing rights.

Taken together, the rapid development of TPG Opportunities Partners should provide the firm with a steady stream of growth as it continues to work on the size and scope of its buyout business. It’s an encouraging sign for a manager that has had its share of headwind blowing through its core business in recent years. It also speaks to its entrepreneurial energy and drive, which appear undiminished.