Fine for now

Those who entertained the notion that an absence of debt funding for larger buyouts and consequent hiatus in deal flow would naturally lead investors to withhold fresh capital from the LBO space were given pause for thought this week. Just a few short months after news emerged that CVC Capital Partners was in discussions about a new €11 billion fund, a source close to the European buyout firm was able to confirm reports that it had capped the vehicle ahead of target at more than €12 billion.

Of course, the success of one fundraising should not lead to the assumption that LBO funds will have little trouble continuing to emulate the extraordinary success they have enjoyed on the fundraising trail over the last few years. Because many of the larger global funds have already been to market in 2006 and 2007, further evidence of success is hard to come by.

But what evidence there is suggests that 2008 will be far from a bad fundraising year. Giant US-based buyout groups such as The Blackstone Group, TPG and KKR (which recently announced it was seeking $30 billion of fresh firepower) are all in the market – and it would be brave to bet against them achieving their goals. Silver Lake’s latest fundraising experience was a little nuanced as it closed just shy of a $10 billion target at $9.3 billion, but this still ensured that the fund raised around double the total of its predecessor. In Europe, meanwhile, Apax Partners is expected soon to close a fund that reports suggest has moved beyond €11 billion.

Move down into the mid-market and it seems that a frenetic fundraising year is under way. Vitruvian Partners, the UK start-up fund, recently raised €925 million and, over the last couple of weeks, the closes have come thick and fast: Italy’s Investindustrial, Norway’s HitecVision and Switzerland’s Capvis Equity Partners to name but three (all of them comfortably beating targets). While for the mid-market the credit crunch may not be quite such a pressing issue, it is not without worries relating to the economic cycle. Investors, however, do not appear to be deterred.

Part of the reason for this is the extremely rapid rate of distributions LPs have enjoyed over the last few years, which has been fuelled by the recapitalisation boom and which has ensured that they have to undertake a rapid redeployment of capital in order to meet their allocation targets. Among the beneficiaries of the boom have been newcomers to the asset class including certain sovereign wealth funds which, according to a leading placement agent, have made “huge short-term profits”. This, he adds, is giving them the confidence to pursue highly aggressive private equity programmes which “aim to achieve in five years what GIC has achieved in the last 20”.

Add to this the increasing allocations to the asset class from public pensions (US pensions such as Washington State and Texas Teachers have been notably ramping up already bold exposures) and from corporate pensions, plus the emergence of a new generation of endowments, and it is clear that demand for private equity is at an all-time and growing further. Small wonder that CVC chairman Michael Smith expressed confidence at the launch of his firm’s fund that investors would have the capacity to look beyond short-term difficulties in the credit markets.

Private equity, it might seem, has completed the mythical “paradigm shift”. The old rules, in other words, no longer apply. The asset class now has a substantial and attractive performance track record which means that investors are beating a path to its door. What is more, they are prepared to take the long-term view. Increasingly experienced and sophisticated investors are not running for cover at the first sign of trouble. Market perambulations that might have scared them off in the past hold no fear for them any more.

Or do they? The lack of large buyout deal flow may not be having an impact on fundraising but, sure as night follows day, it will have an impact on distributions. And, as funds that have been reliant on leverage are forced to place a little more reliance on equity instead, returns can only go one way (and it isn’t up). Consider also the need to apply fair value to portfolios and the consequent write-downs now splashed all over investor reports. Still not scared?

Fundraising in 2008 looks fine. The question is whether 2009 will be fine, too.