CALLAN INVESTMENTS INSTITUTE Private Markets Trends IN THIS ISSUE pg. 1 Private Equity Fundraising Private Equity Market Environment pg. 3 Regulation Trends Private Equity Returns Spring 2014 Private Equity Fundraising In fundraising, Private Equity Analyst reports that new first quarter commitments totaled $40 billion, with 173 new partnerships formed. Compared to the first quarter of 2013, this represents a 21% increase in committed capital and a 43% increase in new partnerships. However, compared to the fourth quarter of 2013, it represents a decline of $18.2 billion (31%), with a similar number of funds being formed. (The fourth quarter figures were $58.2 billion of commitments and 170 new funds.) Given the relatively moderate pace of new company investments, the strong start in 2014 s fundraising has increased concerns about an accumulating overhang of uncalled capital. The overhang growth has become particularly worrisome since mega-funds started coming back in vogue in late 2013. Plan sponsors have been driven to replenish commitments following strong distributions from private equity portfolios, and appreciation in total plan values due to the public equity bull market. Regarding capital allocations by strategy, venture capital is gaining in popularity. It has been bolstered by a number of high-profile successes in 2013, and rose to 14% of new commitments for the Exhibit 1: Funds Closed Jan. 1, 2014, through March 31, 2014 Strategy # Partnerships Amt ($MM) % Venture Capital 71 5,577 14% Buyouts 58 21,284 53% Subordinated Debt 13 1,865 5% Distressed Debt 4 6,500 16% Secondary and Other 6 1,459 4% Fund-of-funds 21 3,273 8% Totals 173 39,958 100% Source: Private Equity Analyst first quarter up from 9% for all of 2013. Buyouts started off the year with 53% market share, only slightly lower than the first quarter of 2013 (55%), although the total dollar commitments were larger than 2013 s first quarter. Similar to the pattern in 2013, distressed debt is more popular than subordinated debt. Fund-of-funds ticked up in the first quarter to 8% of commitments from 4% for all of last year. Since most secondary funds raised large pools in the last two years, we expect that area to continue to be slow for some time. According to Buyouts newsletter, nine funds have raised more than $1 billion through the first quarter. Apollo Investment Fund VIII has raised the largest amount of capital, securing $6.4 billion toward its final close of $18.4 billion, which well exceeded its $12 billion target. TPG Opportunities Fund III (distressed/turnaround) was second, quickly closing on $3.2 billion and exceeding its $2.5 billion target. Three funds tied for third place, raising $2 billion in the first quarter. KKR closed two funds: KKR Special Situations Fund (distressed/ turnaround), doubling its $1 billion target; and KKR Energy Income and Growth Fund, exceeding its $1.5 billion target. The third fund was Odyssey Professionals V, surpassing a $1.75 billion target. Private Equity Market Environment Buyouts The first quarter produced an increase in deal count, but a decline in total announced dollar volume, which indicates more, but smaller, transactions. According to Buyouts newsletter, the investment pace by funds into companies totaled 370 transactions with announced dollar volume of $22.2 billion. The transaction count was the largest since the fourth quarter of 2007, but the announced dollar volume was less than any of the four quarters in 2013. Five transactions with announced values of $1 billion or more closed during the quarter, Knowledge. Experience. Integrity.
with the largest being the $2.4 billion acquisition of Sedgwick Claims Management Services by KKR. The second largest deal was the purchase of Applied Systems by Hellman & Friedman. The third was the $1.3 billion take private of CEC Entertainment by Apollo. Exit activity and distributions to limited partners continued to be strong, although IPOs slowed from both the fourth quarter and yearover-year. Buyouts reports that 119 private M&A exits of buyoutbacked companies occurred during the first quarter of 2014, with 41 deals disclosing values totaling $22.5 billion. For comparison, the first quarter of 2013 had only $8.4 billion of announced value. Five M&A exits topped $1 billion in the first quarter. The largest was TPG s $2.9 billion sale of Aptalis Pharma to Forest Laboratories. The second largest was JLL Partners $2 billion sale of Patheon to DSM Pharmaceutical Products. The third was Bain Capital s $1.8 billion sale of Applied Systems to Hellman & Friedman. As seen in Exhibit 2, Information Technology companies received 64% of the first quarter s funding, about even with the 63% in all of 2013. Health Care fell to 18% from 24% in all of 2013. Business/ Industrial received 9% of quarterly funding, close to last year s average of 8%. Consumer/Retail rang up 8%, an increase from 2013 s average of 5%. Exhibit 2: 1st Quarter 2014 Venture Investments by Industry $ Invested Industry Sector # Rounds ($000) % Technology 629 6,089,902 64% Health Care 182 1,727,360 18% Business/Industrial 80 872,416 9% Consumer/Retail 56 776,444 8% Other 4 2,821 0% Totals 951 9,468,943 100% Source: National Venture Capital Association There were eight buyout-backed IPOs in the first quarter that floated $3.7 billion, a drop from 18 IPOs raising an aggregate $8.3 billion in the fourth quarter. The largest IPO was the $1.8 billion issuance by Santander Consumer USA, an automotive finance firm backed by KKR, Warburg Pincus, and Centerbridge. The second largest was the $704 million float of EP Energy Global by Apollo and Riverstone. The third saw $390 million raised by RSP Permian, a Natural Gas Partners portfolio company. Venture Capital According to the National Venture Capital Association, new investments in venture capital companies totaled $9.5 billion in 951 rounds of financing. The dollar volume represents the largest amount invested in companies in almost 13 years (since the second quarter of 2001, when $11.5 billion was invested). Funding was up from $8.4 billion in the fourth quarter of 2013, but the number of rounds was down from 1,112. The industry continued to contract as $3.9 billion more was invested in companies than was committed to partnerships. The largest deal during the quarter was a $325 million expansion round in Dropbox, an online storage and file sharing company, by Sequoia. Two expansion-stage financings for $200 million tied for second place. One was community marketplace company AirBnB, funded by Andreessen Horowitz and Sequoia. The other was mobile messaging company TANGOME, funded by Access BridgeCap Ventures, DFJ International, and others. By maturity (Exhibit 3), combined expansion and late-stage investments received 68% of new capital funding in 459 rounds of financing, an increase from 64% in all of 2014. Early-stage and start-up companies received the remaining 32% of funding across 492 financing rounds. In recent quarters there has been a tilt toward more mature companies. Exhibit 3: 1st Quarter 2014 Venture Investments by Stage $ Invested Development Stage # Rounds ($000) % Start-Up/Seed 41 124,878 1% Early-Stage 451 2,885,074 31% Expansion 274 3,913,128 41% Late-Stage 185 2,545,863 27% Totals 951 9,468,943 100% Source: National Venture Capital Association Venture-backed M&A exits totaled 105 transactions, with 14 disclosing total dollar volume of $7.5 billion. Both the number of exits and announced value increased from the fourth quarter of 2013 s 92 sales and $6.7 billion of announced value. It is also a huge yearover-year increase from the 86 exits and $1.0 billion of disclosed valuation in the first quarter of 2013. The largest venture-backed M&A exit with a disclosed value was the $3.2 billion sale of Nest Labs (backed by Kleiner Perkins, Lightspeed, and others) to Google. The second largest deal was the $1.5 billion purchase of Air Watch by 2
VMWare. There were 36 VC-backed IPOs in the first quarter with a combined float of $3.2 billion. For comparison, the fourth quarter of 2013 had 24 IPOs and total issuance of $5.3 billion. The year-overyear comparison increased from only eight IPOs aggregating $717 million. The largest IPO was Castlight Health, which raised $204 million and was backed by Venrock, Oak, USVP, and others. Regulation Trends SEC Audits: The Securities and Exchange Commission has been engaged in a Presence Exam Initiative intended to establish its regulatory practice in the private equity industry. It recently released information on preliminary findings, primarily through a well-publicized speech ( Spreading Sunshine in Private Equity ) given on May 6 by Andrew Bowden, Director, Office of Compliance Inspections and Examinations. The full text is available at SEC. gov under the News/Speeches sub-menus. The general observations were that after over 150 audits, the commission has concerns in the areas of conflicts of interest, compliance with limited partnership agreements, and lack of transparency. The speech also highlights a number of areas where violations may have occurred, particularly in the areas of expense allocation and the charging of fees to portfolio companies. They also cite fundraising documentation and company valuations as areas for additional attention. The SEC s initial commentary was intentionally non-specific, and Callan will continue to monitor the SEC s public commentary on the audits and highlight relevant clarifications. Bank Loans: In March 2013, the Federal Reserve, Office of the Comptroller of the Currency, and the Federal Deposit Insurance Corporation issued regulatory guidelines intended to curb the issuance of leveraged loans. A key debt level metric referenced in the guidelines is six times EBITDA. Banking participants have commented that the guidelines are ambiguous, but Reuters reports that the agencies are seeking to clarify the guidelines and in April launched audits intended to increase enforcement. In today s market, pricing is such that leverage commonly exceeds the guideline amount. Private Equity Returns Year-end numbers, as represented by the Thomson ONE private equity database, are shown in Exhibit 4. Public markets soared in the fourth quarter of 2013, and private equity had its best quarter since the market bottomed in the first quarter of 2009. The All Private Equity return was 7.1% for the fourth quarter and 20.7% for the full year 2013. For comparison to public markets, the S&P 500 rose 10.5% for the fourth quarter and 32.4% for the year. The Russell 3000 was up 10.1% and 33.6% for the quarter and year, respectively. By strategy type, Buyouts had the highest return for the quarter, rising 7.6%, followed by All Venture (6.0%), and Mezzanine (3.4%). Exhibit 4: Private Equity Performance Database (Pooled Horizon IRRs Through Dec. 31, 2013) Strategy 3-Mo 1-Yr 3-Yr 5-Yr 10-Yr 20-Yr All Venture 6.0 15.6 4.6 4.5 5.1 15.1 All Buyouts 7.6 22.4 11.1 11.9 10.4 10.5 Mezzanine 3.4 14.0 6.4 5.9 6.6 7.4 All Private Equity 7.1 20.7 9.7 10.6 9.4 11.2 S&P 500 10.5 32.4 16.2 17.9 7.4 9.2 Source: Thomson ONE The effects of the Great Recession s bear market are beginning to roll off the five-year horizon figures. The All Private Equity five-year return increased 4%, and the S&P 500 return jumped 8%, relative to the September 30, 2013 figures. Next quarter, the final negative period of the bear market (1Q 2009, S&P 500-11%) will roll off the five-year horizon calculation, so we expect another meaningful increase. Since the public markets turned up in the second quarter of 2009, the private equity market has now cumulatively underperformed the public equity market for almost five years. This is a unique situation for private equity. In the prior tech bubble downturn, private equity began to outpace public equity indices after three years. The recent four and three-quarters years have also been an unusually strong and sustained period for public equity results. Returns approaching 20% are well above long-term expectations for U.S. equity markets. Did You Know... As an independent third party in the private markets arena, Callan Associates has information and access to both buy- and sell-side industry participants to provide research-based answers to any questions our clients may have regarding the private equity asset class. Callan welcomes the opportunity to conduct customized research or devise client-specific solutions in the private markets area. For private equity inquiries, contact your Callan consultant or Gary Robertson at 800.227.3288. Knowledge. Experience. Integrity. 3
Private Markets Trends is published quarterly by the Callan Investments Institute for professionals of the institutional investment community. Private Markets Trends discusses the market environment, recent events, performance, and other issues involving private equity. For private markets inquiries, contact your Callan consultant or Gary Robertson at 800.227.3288. Author Gary Robertson is the manager of Callan s Private Equity Research group. Gary is responsible for the firm s Alternative Investments consulting services. He is currently secretary of Callan s Client Policy Review Committee. Editor-in-Chief Karen Witham Publication Layout Nicole Silva About Callan Callan was founded as an employee-owned investment consulting firm in 1973. Ever since, we have empowered institutional clients with creative, customized investment solutions that are uniquely backed by proprietary research, exclusive data, ongoing education and decision support. Today, Callan advises on more than $1.8 trillion in total assets, which makes us among the largest independently owned investment consulting firms in the U.S. We use a client-focused consulting model to serve public and private pension plan sponsors, endowments, foundations, operating funds, smaller investment consulting firms, investment managers, and financial intermediaries. For more information, please visit www.callan.com. About the Callan Investments Institute The Callan Investments Institute, established in 1980, is a source of continuing education for those in the institutional investment community. The Institute conducts conferences and workshops and provides published research, surveys, and newsletters. The Institute strives to present the most timely and relevant research and education available so our clients and our associates stay abreast of important trends in the investments industry. 2014 Callan Associates Inc. Certain information herein has been compiled by Callan and is based on information provided by a variety of sources believed to be reliable for which Callan has not necessarily verified the accuracy or completeness of or updated. This report is for informational purposes only and should not be construed as legal or tax advice on any matter. Any investment decision you make on the basis of this report is your sole responsibility. You should consult with legal and tax advisers before applying any of this information to your particular situation. Reference in this report to any product, service or entity should not be construed as a recommendation, approval, affiliation or endorsement of such product, service or entity by Callan. Past performance is no guarantee of future results. This report may consist of statements of opinion, which are made as of the date they are expressed and are not statements of fact. The Callan Investments Institute (the Institute ) is, and will be, the sole owner and copyright holder of all material prepared or developed by the Institute. No party has the right to reproduce, revise, resell, disseminate externally, disseminate to subsidiaries or parents, or post on internal web sites any part of any material prepared or developed by the Institute, without the Institute s permission. Institute clients only have the right to utilize such material internally in their business. 4
Corporate Headquarters Regional Offices Callan Associates 600 Montgomery Street Suite 800 San Francisco, CA 94111 800.227.3288 415.974.5060 Atlanta 800.522.9782 Chicago 800.999.3536 Denver 855.864.3377 New Jersey 800.274.5878 www.callan.com