WHY KKR AND OTHER MEGA-FIRMS CAN JUMP-START NEW PE STRATEGIES. In this two-minute video, Bloomberg’s Devin Banerjee delves into what is arguably the principal competitive advantage enjoyed by the globe’s handful of exceptionally large private equity fund managers: huge balance sheets. Using capital from the largest balance sheet in the industry – $6.9 billion – KKR & Co. is funding almost half of a new PE lending vehicle for the recovering global shipping industry, one of the hottest destinations for PE investment today. “KKR would certainly tout this as a strength – they can bring together their expertise and their capital to create a new offering,” says Banerjee. They’ve used their balance sheet in the past to seed new businesses and this is another example.” Mega-firms are building teams of specialists from scratch, diversifying their PE offerings and raising smaller but more numerous funds with the aim of improving their long-term sustainability as businesses.
ONE BIG CHALLENGE FOR PE FIRMS REMAINS INSTITUTIONALIZATION, even for some mega-firms, a point underlined by a Financial Times profile of TPG and its larger than life founding partner, David Bonderman. Although TPG manages a relatively whopping $56.7 billion throughout the world and across a wide range of private equity strategies, and while “there is no question that there is plenty of talent” at the firm, “Mr. Bonderman and TPG are facing questions from analysts and investors about succession,” writes the FT. “Such questions are not unusual at big firms, but they are growing louder around TPG,” since Bonderman is 70 years old “and has been the dominant personality” at the group. Ironically, as TPG tries to move away from its founding partner’s ‘intuitive and informal style” by introducing “more process” into its decision making, it “may need Bonderman’s charisma more than ever. When fundraising is slow, it is Mr. Bonderman who gets on the plane to talk to investors.”
IN THE U.S. THE “IRS IS KNOCKING” ON PRIVATE EQUITY’S DOOR. U.S. PE firms “have an ugly new headache: a wary look by the Internal Revenue Service at one of their preferred acquisition techniques,” warns Fortune’s Dan Primack. “The technique involves loaning cash stockpiled in a fund’s offshore affiliate to a related U.S. holding company set up to acquire a separate firm, a multistep move that typically generates lucrative tax deductions. The IRS wants to know whether PE funds and their portfolio companies, are skirting so-called interest-stripping rules by disguising taxable equity investments as tax-deductible loans. Scrutiny of intercompany loans could lead to ‘tens of billions of dollars in adjustments’ for companies and firms of all stripes,” not just those associated with PE, Primack writes, citing Ernst & Young principal and former IRS special counsel, Chris Faiferlick. “No challenges involving PE-backed deals have yet spilled into public venues, suggesting that the private equity look is still in an early stage.”
SWEDEN’S TAX AUTHORITY DEMANDS GPs PAY $814 MILLION IN TAXES on carried interest dating back to 2005. “Sweden has been trawling through tax returns and earnings declarations” of general partners in the country’s PE firms and “wants to tax the majority of private equity carried interest at the highest income tax rate of 55 percent,” and not at the 30 percent capital gains rate that was paid, reports Reuters. In the latest example of this, well known buyout firm EQT has been hit with a “$100 million tax bill” that the firm and its partners – following the example of other Swedish GPs – plan to challenge. “Our view is that nothing new has been found in the investigations that warrants a retroactive change,” EQT chief operating officer Johan Bygge told Reuters. GPs at Altor, IK Investment Partners and Nordic Capital also face millions in tax bills and are contesting what they believe is an unjustified reinterpretation of the tax code.
PUBLIC FUNDS ARE INCREASINGLY INVESTING DIRECTLY INTO PE, observes a New York Times DealBook story that documents the phenomenon. Pension funds, sovereign wealth funds and others are now finding “ways to put their money to work together, without paying fees to private equity firms and hedge funds,” DealBook reports. “The big investors are saying, ‘wait a minute, we don’t have to do this anymore,’ ” says Leo de Bever, chief executive of the Alberta Investment Management Corporation, a Canadian public pension fund. “When Mr. de Bever took over Aimco “in 2008, it had relationships with about 50 private equity firms,” a number cut to 12 today. “Funds that are graduating to investing alone generally say they still use” outside PE managers “for areas in which hiring an expert would be hard.” This helps explain the push by many general partners to develop increasingly specialized funds.
BARING PRIVATE EQUITY ASIA ILLUSTRATES PE’S CONTRARIAN NATURE, notes the Wall Street Journal. The newspaper reports that one of the industry’s largest pan-Asian general partners, Baring Private Equity Asia, “agreed to acquire about 68 percent in software company Hexaware Technologies” for $434 million. The deal is BPEA’s “largest investment in India” and “comes at a time when the Indian economy is going through a difficult phase.” The rupee has fallen to a record low this month as foreign investors in Indian stock and bond markets pull money out, “partly because of the country’s economic troubles and partly due to fears that the U.S. will soon start scaling back easy-money policies that had driven up asset prices in emerging markets.” Meanwhile, Private Equity International notes that the Hexaware deal is “Baring’s second significant investment in India recently,” with the firm investing “$256 million” for 14 percent of cement producer Lafarge India in May. That was Baring’s “largest investment in India at the time.”
CalPERS’ LATEST PRIVATE EQUITY QUARTERLY REPORT IS OUT. The 27-page report from the California Public Employees’ Retirement System contains a wealth of information about one of the largest pension fund PE programs in the world, with $31.4 billion in assets at the end of June. Among the highlights: CalPER’s net cash flow from private equity is close to record levels, with distributions outpacing calls in the second quarter more than fourfold, helped by sales on the secondary fund market, while the program’s general partners have “material” un-invested commitments of $9.3 billion, “over half of which is from the 2007-2008 vintage years.” Those vintages represent a fund-set where investment periods, on average 5 years long, are expiring, freeing up cash for new commitments by limited partners. CalPER’s one-year, three-year and ten-year PE returns are respectively 13.6 percent, 14.5 percent and 12.5 percent.
FOR PE MANAGERS “DIVERSITY HAS BECOME A BUSINESS IMPERATIVE,” declares Carnegie Corporation co-chief investment officer Kim Lew. In this 9-minute video from Privcap, Lew explains the importance of team diversity when it comes to private equity investment. “There are basics needed in this industry,” says Lew. “You have to be able to model, you have to run the numbers, but independent of that, you need different opinions” if you want to be “great.” Teams with members who have a wide range of experiences, including different ethnic and socio-economic backgrounds, effectively get an “extra point” when Carnegie is selecting general partners.