Pressure Is On Private Equity?
Carlyle Group LP's second-quarter results reaffirmed that it is a sellers' market for private-equity firms, as the firm reported it cashed out of investments at three times the rate at which it made new ones.Earlier this week, I discussed why smart money is getting out and looked at the implications for the overall market and whether we've reached a top. Buyout firms are taking advantage of hot credit and equity markets to realize on their investments and lock in gains. This is good news for them and their investors.
The firm announced results that fell short of analysts' expectations but said it had its best fundraising period since the financial crisis, raising nearly $7 billion.
The buoyant stock market that has lifted company values this year has been both boon and bane for buyout firms, which are reaping profits from past deals in huge volume this year but are finding it difficult to identify new deals where they can expect the 20% or better annualized returns such firms target.
"The overall investment environment has grown more challenging," said William Conway Jr., a Carlyle co-founder and co-chief executive. "With the world awash in liquidity, interest rates at rock bottom levels and asset prices being bid up, it has become increasingly difficult for us to compete when underwriting our investments, particularly in the U.S., to a 20% to 25% internal rate of return."
That is a contrast to last year when Carlyle was among the most active private-equity investors, conducting several multibillion-dollar buyouts.
During the second quarter, Carlyle collected $3.9 billion selling out of investments—primarily in real estate and stakes in companies it has already taken public—while investing $1.3 billion in new deals. That volume and ratio of sales to investments was roughly the same in the first quarter.
The sluggish buyout activity comes as Carlyle is as flush as ever. The firm raised $6.9 billion for its funds, marking its best fundraising period since the financial crisis, said David Rubenstein, also a co-founder and co-chief executive. Carlyle had $180.4 billion in assets under management at the end of June, including more than $20 billion ready to invest in its corporate buyout funds.
Although the asset sales overall generated profits and its latest buyout fund began paying fees during the second quarter, Carlyle's results fell below analysts' expectations.
Carlyle posted a $3.3 million loss, or 7 cents a share, up from a 26-cents-per-share loss the same period a year earlier, a quarter during which the Washington, D.C.-based firm was a public company for only part. The recent quarter's loss was attributable mostly to charges Carlyle took converting private partnership units into shares.
The firm reported economic net income of $156 million, up from a loss of $57.2 million a year earlier. Economic net income is a metric used to gauge publicly traded private-equity firms' performance and the value of their investments. It counts both realized and unrealized gains and also factors in accounting quirks that occur when partnerships transform themselves into public companies.
Performance fees, which represent the firm's slice of deal profits, were up from a loss last year that was related to unrealized losses. The value of its funds in which the firm and its shareholders collect a portion of the profits rose 3% during the second quarter, down from 7% growth reported in the first quarter.
Distributable earnings, the portion of profits from which shareholder payouts come, were $163 million, 41% higher than a year earlier. The firm said it would pay a dividend of 16 cents a share for the quarter.
Distributable earnings, which include cash profits that flow back to investors and which Carlyle executives say are the best measure of the firm's performance, benefited from gains made selling big blocks of stock in companies, including oil explorer Cobalt International Energy Inc., television-ratings business Nielsen Holdings NV and car-rental business Hertz Global Holdings Inc. Carlyle executives said those and other so-called block sales generated between two and five times the firm's original investments in the companies.
Carlyle shares were down in Wednesday afternoon trading. The stock, which is up about 6.6% on the year, hasn't fared nearly as well as that of rival firms Apollo Global Management LLC, KKR & Co. and Blackstone Group LP, which are each up more than 30% on the year.
Carlyle's shares have underperformed peers' in part because Calpers, the California public pension fund, in early June liquidated its stake in the firm, boosting the number of shares that are publicly traded by more than 20%, depressing the price.
The bad news is that top buyout funds like Carlyle are now flush with cash and the overall investment environment is extremely challenging, especially in the United States. William Conway summed it up well: "With the world awash in liquidity, interest rates at rock bottom levels and asset prices being bid up, it has become increasingly difficult for us to compete when underwriting our investments, particularly in the U.S., to a 20% to 25% internal rate of return."
Of course, all investors are grappling with these issues but for private equity, it's particularly hard. Their average holding period is six years and they typically buy unloved or underperforming companies, fix them, cut costs, and then take them public in a few years, often after loading them up with debt and extracting huge special dividends.
There’s a big bottleneck of companies PE firms bought before the financial crisis, and as the median holding period approaches six years, investors are getting antsy to cash out. According to Mergermarket.com, while the number of new buyouts has dropped dramatically, the pace of exits has accelerated: $68.6 billion in the second quarter, double the dollar volume of the first quarter.
But allocations to private equity, most of which are coming from public pension funds, are continuing with the bulk of the money going to well known funds. Steven Perlberg of Business Insider reports, Private Equity Firms Bumped Up Their Fundraising Volume 147% Since Last Quarter:
U.S. private equity firms' fundraising volume rose to $42 billion last quarter, a 147% jump from the first quarter of 2013.
The level was the highest since March 2009.
After a slow first quarter, portfolio company sales (or "exits") doubled from Q1 to Q2, to $42 billion as well.
Last month, a report from Preqin summed up the Q2 results:
Private equity fundraising was very strong in Q2 2013, with the highest quarterly value raised since the onset of the financial crisis in late 2008. The fact that the average size of private equity funds closed in Q2 2013 was $800mn and experienced managers dominated the fundraising environment, shows that investors are increasingly looking to back fund managers with a demonstrable track record.And these charts, via the Private Equity Growth Capital Council, show the state of the industry.