In the fast lane

Pacific Equity Partners in Sydney is preparing to organise a A$4 billion Australasian buyout fund – by far the largest such entity ever raised. Philip Borel reports.

Australian private equity is growing rapidly, and Pacific Equity Partners is growing with it. At a recent client meeting last October, held at the auditorium of Taronga Zoo in Sydney, the firm told its limited partners of plans to raise a new private equity fund later this year. At A$4 billion (€2.39 billion; $2.39), this new fund, PEP's fourth, will not only mark a big jump in size from the firm's previous investment vehicle, which raised A$1.276 billion in January 2006. It will also be by far the largest pool of private equity capital ever organised by an Australian firm – PEP Fund III is currently the largest.

Even in the context of Asia Pacific's ongoing private equity boom, these numbers are very large indeed. According to a recent survey compiled by PricewaterhouseCoopers and citing data from Thomson Financial and Australian venture capital association AVCAL, the average Australian private equity fund in 2000 had a capitalisation of approximately A$100 million; in 2006, the survey said, the average fund size was A$400 million.

PEP was founded in 1998 by former Bain & Company management consults Rickard Gardell, Simon Pillar and Tim Sims as well as Paul McCullagh, an Irish-born investment banker by background.

Back in the late 1990s, after many years of working together as advisers, the four men set out to apply the same value enhancing methodologies they had honed in their previous careers, only this time as principal investors in their own right. Bain Capital, the massively successful LBO group that grew out of Bain & Company in the US, had demonstrated how this might be done.

Gardell, a native Swede who has been working in Australia since 1987, says with the Bain Capital story already well advanced, the group had a clear view of the business model it aspired to right from the beginning. Sims, who like Pillar grew up in the UK, says: “We had a track record of value creation, having sold our time at very high prices for many years. The only question was, would we be able to take on financial leverage and change our relationship with the companies we would work with.”

They were indeed. PEP's first investment was the purchase of Frucor, a non-alcoholic beverage business in New Zealand. PEP acquired the company for NZ$67 million (€35.8 million; $47 million) and within three and a half years made a profit of more than 10x. Its first institutionally backed fund closed on A$142 million in December 1998.

At the time, Australasian private equity was still in its infancy, but since then, the environment has changed dramatically. Practically an unknown funding mechanism ten years ago, private equity Down Under is now a high profile and increasingly influential part of corporate finance in the region.

As McCullagh notes, attitudes have changed in favour of buyout funds: “Corporate chairmen have become more accustomed to the idea of divesting non-core parts of their businesses, and the investment banks are now very comfortable with the idea of proposing private equity funds as potential buyers. Likewise, entrepreneurs and family owners looking for an exit have learned that they don't have to sell to a rival or go public – private equity is now recognised as an alternative.”

Benefiting from the transformation, a number of institutionally backed, local private equity pioneers have established themselves, including PEP, CHAMP Private Equity and Ironbridge Capital. CHAMP, a joint venture with New York-based mid-market investor Castle Harlan, is currently investing its second buyout fund, which raised A$950 million in 2005; Ironbridge, a spin-out from Gresham Private Equity, closed its second fund on A$1.05 billion in November 2006.

In addition, large international buyout investors such as Kohlberg Kravis Roberts, Texas Pacific Group and CVC have made some sizeable investments in the country, deals that have helped the industry become even more visible.

From the beginning, PEP has seen itself as a leader of the local pack, “front footing” the market as Gardell puts it. Now that Australasian buyouts have entered a new phase of development, the firm sees an opportunity to pull away from the competition: hence the plan for a A$4 billion fund.

According to the four founders, there is a growing pipeline of deals in the region that are currently too big for local funds and too small for the global groups – between A$400 million and A$2 billion in enterprise value. PEP wants to fill the gap.

According to Pillar, the arrival of the large US houses in the region, and the publicity surrounding their recent efforts to acquire some very large assets such as supermarket group Coles Myer and Qantas, the airline, have changed the opportunity set in the market. These transactions (Coles Myer was rejected) have not been without controversy, with local journalists and politicians critically examining the concept of take-privates, but Pillar says: “This has been a very positive development. It's opened up a market segment that was previously untouched by private equity,” he says.

PEP sees itself well positioned to exploit the new deal flow. “Private equity is very much a local business,” Gardell says, “and as a local fund, we know how to deal with local sensitivities.”

The international sponsors, adds Sims, are not as focused on Australasia as the indigenous groups: “For them, this region doesn't have the necessary depth. Other parts of Asia have been delivering less than they expected, which is why they have spent more time here. But once the Japanese buyout market picks up for example, Australia won't be as hyperactive as it has been recently.”

Meanwhile the local groups, the PEP founders argue, do not have sufficient capital at their disposal to pursue larger transactions on their own. To quote Sims again: “At the moment, large deals can only be done in a fairly messy way. We've had some good experiences partnering with other funds on specific deals, but club deals make it harder to run portfolio companies the way we want to – which is why we would like to be able to make larger investments on our own.”

If last year's activities are anything to go by, PEP looks ready for a new challenge. In 2006, the firm completed five buyouts, including three transactions in New Zealand, plus a number of addons to existing investments. It is a big tally, and Sims admits to being “a little surprised we are about to go back to the market with a new investment vehicle so soon after closing Fund III. But we're delighted with the reason for that – last year was exceptionally strong.”

In the local press, PEP's work rate has earned it the label “most aggressive” as far as regionally active private equity providers are concerned. Gardell rejects the expression as sounding “extreme” and suggests “very targeted” instead: “We're pretty binary: if we like a deal we go at it hard; if we don't like it, we don't go at all.”

Pillar adds that PEP looked at 102 investment opportunities last year, undertook detailed due diligence on 36, bid on ten, completed five and signed a further two.

The two pending ones are publicto-privates: a A$1.8 billion transaction for Flight Centre, a travel company, and an A$814 million offer for Veda Advantage, a credit services information company formerly known as Baycorp Advantage, alongside Merrill Lynch Global Private Equity.

Once the Japanese buyout market picks up for example, Australia won't be as hyperactive as it has been recently

Tim Sims

In addition, PEP also completed three exits in 2006. In total, the firm invested $A490 million of equity last year and distributed $A397 million back to investors.

Once the two pending transactions are in the bag, PEP's available capital will be all but exhausted. With the ground already cleared for another marketing campaign, the firm expects strong interest for its new offering from existing clients.

According to McCullagh, PEP has forged close ties with a group of international private equity investors, including a number of US endowments. He says: “Many of our LPs initially went for regional funds investing in Asia-Pacific, but then realised they'd be better serviced by a local player.”

In addition to quarterly briefings by telephone, the firm's limited partners visit Sydney once a year for a “highpowered” 48-hour discussion of anything to do with PEP and private equity at large. The PEP partners also spend time overseas to visit their clients periodically.

After the most recent annual gathering in Sydney in October, PEP is convinced that the fundraising will go well. Concludes Sims: “We are confident we can fill a A$4 billion fund with pent-up demand.”

If things go to plan, a new type of Australasian private equity investor will be created: the large, locally based mid-market specialist. PEP's founders are certain this is a winning formula. Their peers will be watching with interest.