The financial world is celebrating the birth of the first $10-billion (U.S.) private equity fund. It's the latest offspring of Blackstone Group, a pioneer in buyout circles that was created two decades back by celebrated Lehman Brothers deal makers Pete Peterson and Stephen Schwarzman.
The $12.5-billion committed to Blackstone's latest buyout fund eclipses recently set records for similar funds run by Goldman Sachs, Carlyle Group and Kohlberg Kravis Roberts. & Co. While the numbers are staggering, there's an emerging school of thought that says these big babies mature into great investments.
In Canada, the scale is slightly smaller -- Onex Corp. set a domestic record when it raised a $1.5-billion fund last year. But familiar names such as Edgestone Capital Partners are out gathering new money, and the institutions are all boning up on the hot sector. The pension funds are following the likes of the Ontario Teachers Pension Plan Board, which has registered annual returns of 25 per cent plus from private equity since moving into the space in 1991.
Public markets -- that is, conventional stocks and bonds -- just can't match the sizzle of private equity. The institutional world is transfixed with the notion that alternative assets -- private equity, hedge funds and real estate -- offer better returns and less risk than conventional stock and bond holdings.
Private Equity Intelligence, a British-based newsletter, forecasts a record $200-billion will be earmarked for about 300 new private equity funds this year, with about 12,000 institutional investors throwing in their cash.
However, even as they sign cheques, the institutional types cluck-cluck about how the buyout market is getting overheated. There's intense competition for every deal.
For example, private equity funds went toe to toe with two industry players in the bidding for A&P's Canadian grocery operations. All this competition brings fears that future returns won't be as robust as those of the past.
So why are the institutions lining up for monster funds such as Blackstone? Simple. Established managers can attract billions of dollars into new funds based on the simple fact that the largest players have always posted the best numbers, and seem likely to continue to do so.
The Private Equity Intelligence team crunched the numbers, and found that the largest 25 per cent of funds launched each year in North America boasted an internal rate of return that was 2.4 per cent higher than the average return of all their peers. That qualifies as substantial out-performance in the institutional world.
There are a number of reasons why bigger is better. Private Equity Intelligence suggests part of the premium may reflect the "standards of professionalism and due diligence at the largest buyout houses." Having dealt with fund managers large and small, I'd disagree with that, as the big guys don't have a monopoly on brains.
However, Private Equity Intelligence also did an analysis of what the different funds are capable of bidding for, and made a telling case for bigger funds facing less competition on larger deals.
Working in their home European market, the newsletter looked at the number of private equity funds launched since 2002 that would be capable of completing a buyout worth less than $500-million. That would be a medium-sized Canadian company, much smaller than recent targets such as Masonite or the Boeing factories that Onex bought.
On these mid-sized deals, Private Equity Intelligence came up with at least 45 possible bidders, all less than three years old.
Even at the $1-billion level, there were dozens of private equity players circling, capable of completing a purchase with less than 10 per cent of their total firepower.
Only once the size of the deal broke through the $2-billion range did the field start to thin, with fewer than 10 funds still in the game. Keep in mind that $2-billion is still small potatoes for this crowd. Several of the biggest funds recently teamed up to buy SunGard Data Systems for $11-billion.
"It is clear that the largest funds face relatively less competition than the middle market," concluded Private Equity Intelligence. "This should continue to be the case, and there are therefore good reasons to continue to expect the out-performance of larger buyout funds to persist."
We've now got a smart, aggressive private equity fund managers armed with more financial firepower than ever before. It's a potent combination, one we've never seen before.
With $10-billion private equity funds now roaming the land, $10-billion-plus buyouts will become more common. Getting these big deals right will yield spectacular returns, well above what's accomplished by smaller rivals. But there's bound to be some equally spectacular failures.
Primo sale in the works at Kraft
Kraft Foods Inc. is putting its Primo pasta and Del Monte canned fruit and vegetable divisions in Canada up for sale, the second time the units have been on the auction block.
According to The Daily Deal on-line news service, Kraft is selling divisions that record annual revenue of $300-million.
The units were put on the market in 2001, but no buyers were found. Kraft Canada spokeswoman Susan Davison said she could not comment on "rumours and speculation."
Kraft is reported to have hired investment bank Genuity Capital Markets. In January, Kraft announced plans to shut down its Canadian condiments business.
Andrew Willis