Hiding Private Equity Details?
The New York State Teachers’ Retirement System will tell you that its private equity portfolio has generated a net IRR of 11.1 percent through the end of June 2013. But don’t ask for the details. The pension fund believes that the returns of individual funds are trade secrets, according to sister publication Buyouts.I've already covered bogus private equity fees as well as CalPERS' legal battle with blogger Yves Smith of Naked Capitalism. It seems like large public pension funds are public as long as it suits their needs, or more likely, those of their big and powerful private equity partners who basically run the show via the political back channels.
Responding to an open-records act request by Buyouts earlier this year, New York State Teachers’ did provide some insights as to where its returns are coming from. Since inception through June 30, U.S. buyout funds, which account for about half of the private equity portfolio by market value, led the way with a 13.6 percent IRR and 1.5x investment multiple, according to documents provided by the pension fund.
That is followed by U.S. special situations funds (19 percent by market value) with a 12.8 percent IRR and 1.4x investment multiple; and international funds (17 percent of market value) with a 10.0 percent IRR and 1.4x investment multiple. Venture capital, representing 13 percent by market value, lagged in last place with a 3.9 percent IRR and 1.2x investment multiple.
The documents portray a large and active private equity program at the roughly $95 billion pension fund. As of Sept. 30, New York State Teachers’ had a $7.4 billion private equity portfolio consisting of commitments to 168 limited partnerships managed by 79 buyout and venture capital firms. Sponsors backed more than once by the pension fund include ABRY Partners, The Carlyle Group, Hellman & Friedman, Silver Lake and TPG Capital.
The state pension fund’s recent pace of commitments has been accelerating. Through Sept. 30, the pension fund had $15.9 billion in outstanding commitments, up from $14.9 billion at year-end 2012, suggesting it had made fresh commitments of $1 billion through the first nine months of last year, according to the documents. In 2012 the pension fund committed an estimated $1.6 billion, way up from an estimated $900 million in 2011 and $200 million in 2010.
But when it comes to individual funds, the pension fund draws the line at providing basic information such as the name of each limited partnership, the amount committed and the amount drawn down. In its February open-records request, Buyouts asked for IRRs and investment multiples for each partnership, along with management fees. The pension fund responded that those numbers were off limits. It cited a provision of the state’s open-records act that lets it deny requests of information that “would if disclosed impair present or imminent contract awards” and “are trade secrets …”
In our appeal of that decision, we pointed out that sister state pension funds such as the Teachers’ Retirement System of the City of New York have been disclosing such details about their funds “with no apparent ill effects” on the general partners.
But Kevin Schaefer, the records appeals officer for the pension fund, wasn’t convinced. In his March 6 reply by letter, he denied our appeal. He went through six factors used to determine whether information is a trade secret immune from disclosure. The first, he wrote, is “the extent to which the information is known outside the business.”
Buyouts possesses similar information—IRRs and investment multiples, for example—for several funds that are backed by New York State Teachers’ because they are also backed by New York City Teachers’; among them are The Blackstone Group’s fourth and fifth funds. Schaefer did not view our argument through the same lens. The information made public by New York City Teachers’, he wrote, “is specific” to that pension fund and not New York State Teachers’.
The second factor was similar to the first, while the third of six factors, Schaefer wrote, is “the extent of measures taken by a business to guard the secrecy of the information.” Buyouts possesses detailed fund information on hundreds of limited partnerships disclosed by sponsors via their pension backers around the country.
But again, Schaefer did not see it this way. “General partners of funds,” he wrote, “take measures to ensure the confidentiality of their investment strategy and fund level performance by providing it only to investors and customarily under confidentiality obligations.” At press time a spokesperson for New York State Teachers’ added in an email that ”the NYS and NYC are separate and distinct organizations which, among other differences, include separately negotiated investment agreements with potentially unique rights, obligations and liabilities—including those governing confidentiality requirements and the protection of trade secrets.”
Our request fell short on the other three factors as well.
Buyouts hasn’t decided whether to continue the battle. It should be obvious by now that no harm results from disclosing fund return data, which has been available from pension funds like the California Public Employees’ Retirement System for years following lawsuits early last decade by the San Jose Mercury News.
Put aside for the moment that I am a journalist who likes reporting on juicy return data. Is it wise to hide from New York State Teachers’ Retirement System pensioners—including both my parents—how individual money managers are performing, and how much they’re charging?
A recent Bloomberg story reported that the U.S. Securities and Exchange Commission has found that dozens of private equity firms are inflating portfolio-company fees without notifying investors. If true, I would argue that this industry needs to open its books even further, not less.
Commenting on this latest pathetic display of withholding information from the public, Yves Smith of Naked Capitalism says NY Teachers' exhibits Stockholm Syndrome:
Readers may find it hard to grasp how successful the private equity industry has been in brainwashing investors, particularly large public pension funds. Investors who ought to have clout by virtue of their individual and collective bargaining power instead cower at the mere suggestion of taking steps that might inconvenience the private equity funds in which they invest.Poor Yves, despite the name of her blog, she still doesn't get what capitalism is all about. Even Thomas Piketty, whose popular book on how capitalism has failed the world, doesn't get it. Two guys that do get it are Shimshon Bichler and Jonathan Nitzan who just published their latest, The Enlightened Capitalist, a letter answering the critique of a large asset manager.
Capitalism, my dear readers, isn't about openness, fairness, transparency and meritocracy. Capitalism is all about crisis, sabotage, secrecy and how the elite can screw the unsuspecting masses using any means necessary, ensuring inequality which they require to thrive.
The pension Ponzi is all about how a few powerful hedge funds and private equity funds can ensure their growth by capturing a larger slice of that big, fat public pension pie. They use all sorts of slick marketing, talk up the virtues of diversification and absolute returns, but for the most part, it's all hogwash, all part of Wall Street's secret pension swindle.
I know, I'm being way too cynical. Some pension fund manager is going to write me an angry email telling me how private equity and real estate are the best asset classes and how I'm misrepresenting the benefits of alternative investments in a pension portfolio. I'm not an idiot. I know there are great hedge funds and private equity funds but the reality is the bulk of alternative funds are nothing more than glorified asset gatherers raping public pension funds with outrageous fees.
The question now becomes why are public pension funds and more importantly, private equity funds, not providing more details on their fees and fund investments? Are they complete and utter fools? If they want to win the public relations war in an era of social media, they better hop on the transparency and accountability bandwagon fast!
And by the way, things are far from perfect in the private equity world. Biggest Buyout Gone Bust in Energy Future Dims Megadeals:
The failure of Energy Future Holdings Corp., known as TXU Corp. when KKR & Co., TPG Capital and Goldman Sachs Capital Partners acquired it for $48 billion in 2007, and the stumbles of other huge deals of the past decade have reshaped how major buyout firms go about their trade.
The Dallas-based utility’s bankruptcy yesterday ended the biggest leveraged buyout on record and will wipe out most of the $8.3 billion of equity that investors led by three of the world’s largest private-equity firms sank into the company.
“Energy Future is emblematic of the peak of the buyout boom, when firms did very high-priced, over-leveraged deals that left little room for error,” said Steven Kaplan, professor at the University of Chicago Booth School of Business. “When you buy into a cyclical industry at the peak and you get the bet wrong, bad things happen.”
TXU marked the climax of an era when buyouts stretched into the tens of billions on dollars and Carlyle Group LP’s David Rubenstein predicted there would be a $100 billion LBO. After many of those deals faltered in the 2007-2009 global financial crisis, private-equity investors mostly shied away from companies valued at $20 billion and up, arguing that such buyouts are often overpriced, overburdened with debt and too big to exit easily.
Since the end of 2008, two private-equity buyouts priced above $20 billion have been announced, both in 2013. That compares with 15 in the five years through 2007, according to data compiled by Bloomberg. TPG told investors last year that its next fund will largely stay away from the biggest buyouts, according to a person who attended the firm’s annual meeting in October.
Debt Markets
Three private-equity executives interviewed for this story said they didn’t expect a revival of super-sized buyouts any time soon. The executives asked not to be named because they didn’t want to be seen as criticizing competitors.
Large companies such as Energy Future tend to put themselves up for sale at times when debt markets are wide open and deal valuations are high, said two of the executives.
Those conditions in 2007 set the stage for a buyout that loaded Energy Future with $40 billion of debt, or 8.2 times the company’s adjusted earnings before interest, taxes, depreciation and amortization, a common yardstick for leverage. By contrast, debt averaged 5.3 times Ebitda for all U.S. buyouts in 2013, according to Standard & Poor’s Capital IQ. In the end, the debt combined with a collapse of natural gas prices, to which Energy Future’s revenues are pegged, toppled the company.
‘Poor-Performing’
The biggest buyout funds have lagged behind smaller competitors in recent years, according to London-based research firm Preqin Ltd. Funds of $4.5 billion or more from the 2008 vintage posted median net internal rates of return of 7.8 percent through 2012, compared with 9.3 percent for pools of $501 million to $1.5 billion, the firm’s latest data show.
Of the megadeals announced before 2008, some have turned profits, such as those of hospital owner HCA Holdings Inc., energy pipeline operator Kinder Morgan Inc. and British retailer Alliance Boots GmbH. Others, including casino operator Caesars Entertainment Corp., broadcaster Clear Channel Communications Inc. and credit-card processor First Data Corp., have struggled with weak earnings and heavy debt.
“If you assembled all the mega-cap deals, you would have a poor-performing portfolio,” said Steven D. Smith, managing partner at Los Angeles-based private-equity firm Aurora Resurgence and a former global head of leveraged finance at UBS AG.
Kinder Morgan
Kinder Morgan produced a gain of 180 percent for Carlyle and other backers. At Caesars, Apollo Global Management LLC’s investment has tumbled about 57 percent in value, based on the April 28 closing price.
“The core of what’s wrong with many of these mega-cap deals is that they got priced to perfection,” Smith said. “In this world nothing is ever perfect, and so there are surprises.”
Megadeals can be difficult for investors to cash out of, resulting in longer holding periods and less than stellar returns, said John Coyle, a partner at Permira Advisers LLP, a London-based private-equity firm with more than $30 billion in assets. Many of the targets are too big to sell to another corporation or private-equity group, making the only path to an exit a sale of stock in an initial public offering.
“If you elect to go the IPO route, public equity investors won’t forget that you paid a premium in the bull market of 2006 to 2007,” Coyle said. “They know your exit options are limited, and therefore, with exception for only the rarest of assets, they have the pricing power.”
Valuations Fall
For years it was the fallout of the financial crisis, rather than a reconsideration of deal-making practices on the part of private-equity firms, that put a halt to the biggest deals. Debt financing for LBOs all but evaporated in 2008, when speculative-grade corporate loan issuance in the U.S. fell to $157 billion from a then-record $535 billion in 2007, according to S&P’s Capital IQ. It wasn’t until November 2011 that a corporate buyout once again topped $7 billion in size.
Large company deal valuations fell from the boom-era median of 12.7 times Ebitda to 8.6 for the nine largest corporate buyouts completed from 2009 to 2012, according to data compiled by Bloomberg. The proportion of equity to debt jumped to almost one-to-one in deals such as TPG’s and Canada Pension Plan Investment Board’s $5.2 billion purchase in 2010 of health-care data provider IMS Health Inc. and 2012’s $7.15 billion buyout of oil and gas driller EP Energy by Apollo Global and others.
Investor Pressure
Revived markets have eased the credit drought, as speculative-grade loan issuance rebounded to $605 billion last year, when banks pulled together debt packages for $24 billion-plus LBOs of computer maker Dell Inc. and foods group H.J. Heinz Co. Debt markets have rallied so strongly that $15 billion to $20 billion loan and bond packages for LBOs are possible, said one of the private-equity executives.
Even as lenders have opened their purses, buyout firms continue to apply the brakes to jumbo deals. The executives interviewed for this story, whose firms backed megadeals in the heyday, said some limited partners have urged them to steer clear because of their checkered results.
Limited partners, the pension systems and other financial institutions that supply the money buyout firms invest, have curbed commitments to buyout funds raised since 2009, shrinking sponsors’ capital. Buyout fundraising fell to a post-crisis low of $77.5 billion in 2011 from $229.6 billion in 2008, according to Preqin. Last year, $169 billion was gathered.
Multiple Managers
Clients have also pressed firms to avoid banding together with two or more competitors to raise the billions of dollars of equity that the biggest buyouts demand. It was only by pooling money, as KKR, TPG and Goldman Sachs did in the Energy Future deal, that firms were able to pull off the largest LBOs.
The consortium-backed deals left limited partners that had money with several of the firms with added risk in a single deal. Last year’s $24.9 billion Dell buyout skirted that issue because company founder Michael Dell provided most of the equity, with a single buyout firm, Silver Lake Management LLC, furnishing the rest.
“Limited partners don’t enjoy paying multiple managers fees to be invested in the same underlying companies,” said Jay Rose, a partner at StepStone Group LP, a San Diego, California-based pension-fund adviser.
Fundraising Woes
TPG, which is preparing to raise a new buyout fund this year, told limited partners at its annual meeting last year that it will avoid megadeals unless an opportunity is exceptional, according to an investor who attended. The firm plans to go back to investing in upper middle-market deals with smaller equity contributions, this client said. The firm also said that group deals largely are a relic of the past, according to the person.
The focus on smaller deals also reflects a tougher fundraising environment since the financial crisis. Like many of its peers, TPG expects to raise a smaller fund than the prior vehicle, which gathered $19.8 billion in commitments in 2008. Fund VI, which was 85 percent invested at the end of September, is on a path to run out of capital by mid-to-late 2014, based on the current investment pace, said another investor who attended the annual meeting. TPG this year sought as much as $2 billion from its largest investors to bridge the gap until it starts marketing its main fund.
Despite the obstacles, megadeals have come back before.
‘Short’ MemoriesIndeed, in the private equity and hedge fund industry memories are short, which is why when the next crisis hits, a lot of public pension funds taking on too much illiquidity risk, praying for an alternatives miracle, are going to get clobbered. And even then, they still won't reveal details of their alternative investments. This is why I keep harping on pension governance and real transparency and accountability.
KKR’s $31.3 billion takeover of RJR Nabisco in 1989, by far the largest buyout of its era, barely escaped bankruptcy in 1990 and dealt KKR a loss of about $816 million on its $3.6 billion equity investment, according to a confidential KKR marketing document obtained by Bloomberg News. Not long after that transaction closed, the economy slumped, debt markets fell into disarray and it wasn’t until 2006, when KKR and others bought HCA, that a deal of similar size was struck.
“Even though most firms say they won’t pursue mega-buyouts, in the private-equity industry memories can be short and some just can’t help themselves,” said David Fann, president and CEO of TorreyCove Capital Partners LLC, a San Diego-based pension-fund adviser.
Below, Private Equity Growth Capital Council CEO Steve Judge discusses the SEC probes of private equity firms on Bloomberg Television's “Market Makers.” Notice how this guy avoids answering questions directly on private equity's bogus fees, skirting the issue and singing the same marketing tune on how "private equity is the best asset class for pensions, endowments and foundations."