KKR & Co. co-founders Henry Kravis and George Roberts are struggling to wrap up their first main buyout fund in six years as the firm’s prior fund underperforms and investors scale back private-equity commitments.
North America XI Fund has gathered about $700 million since February, bringing the total to $6.2 billion, the New York-based company said today in its quarterly earnings statement. KKR, which began marketing the fund at the start of 2011, is seeking $8 billion, about half the size of its 2006 pool.
The slowdown reflects a waning appetite for funds focused on so-called megadeals, or takeovers valued at more than $5 billion, as investors become more selective. The North American fund’s appeal has been hurt by returns on KKR’s 2006 pool (PEF1911:US) that are lagging behind the industry median. KKR is raising money outside the main fund, including $4 billion for Asian investments and $2.3 billion for an infrastructure pool.
“We’re seeing a divide in the market,” Rhonda Ryan, who manages $1.3 billion in private-equity assets at PineBridge Investments, said in an interview. “Those whose track record is not stellar are struggling.”
The new KKR fund isn’t the only one facing obstacles in a crowded market. Providence Equity Partners Inc., which is seeking as much as $6 billion, told investors in a meeting earlier this month that it expects to close the fund at $5 billion, according to a person who attended the meeting. Andrew Cole, a spokesman for Rhode Island-based Providence at Sard Verbinnen & Co., declined to comment.
It’s taking firms an average of 13 months to raise a buyout fund, according to Preqin Ltd., a London-based research company. About 260 funds are seeking a combined $219 billion globally. Investors are culling their relationships with private-equity firms to focus on top performers, smaller funds and those that allocate more capital to faster-growing markets.
One firm seeing success is Advent International Corp. The company, which invests in medium-sized companies in Europe and North America, has taken less than nine months to exceed its 7 billion euro ($9.1 billion) target. The firm increased the maximum it could raise, known as the hard cap, to 8.5 billion euros from 8 billion euros in response to demand, a person with knowledge of the talks said earlier this month. The Boston-based firm is attracting money because of its record of good performance and returning cash to investors through sales of companies.
KKR, whose 1989 takeover of RJR Nabisco catapulted it into the top ranks of the leveraged-buyout industry, has a reputation for pursuing big corporate takeovers (KKR:US). Among the deals done by the 2006 fund, which raised more than $17.6 billion, was the acquisition of TXU Corp., later renamed Energy Future Holdings Corp. KKR, TPG Capital and Goldman Sachs Partners acquired the power producer in 2007 for $43.2 billion in the largest leveraged buyout in history.
The company, whose long-term debt has soared to $42 billion, may need to restructure next year, according to Moody’s Investors Service. Derivatives traders are pricing in a 95 percent chance of default within five years for its deregulated unit.
The 2006 fund’s poor performance has hurt KKR’s ability to attract money as fast as it had anticipated, according to a person with knowledge of the matter, who asked not to be named because talks with investors are private. The 2006 pool had a net annualized internal rate of return of 5.4 percent as of March 31, according to a KKR regulatory filing (KKR:US). The median return for North American buyout funds raised that year is 7.6 percent, according to Preqin.
Advent’s previous fund, raised in 2008, generated a 13 percent net annual return as of March, according to the Washington State Investment Board, higher than the median return for funds started that year. Fergus Wheeler, a spokesman for Advent, declined to comment.
KKR posted third-quarter profit of $487.3 million, or 69 cents a share, driven by an increase in the value of its investments, according to today’s statement. Economic net income after taxes, a measure of profit excluding some costs, was a loss of $621.7 million, or 91 cents, a year earlier. Fee-related earnings, which include fees investors pay KKR for managing their money and for completing deals, fell 7.7 percent to $90.7 million.
Investors such as public pension funds and endowments have cut allocations to private equity since the financial crisis, which froze deals and reduced the cash distributions they received.
“The traditional private-equity investors such as U.S. pension funds have allocation constraints,” said Jeremie Le Febvre, founder of Singapore-based TBG Capital Advisors, which advises firms on fundraising. “This is making fundraising more difficult even for the most established brands, especially when they have relied on them too heavily.”
KKR’s marketing effort gained some momentum when the Oregon Public Employees’ Retirement Fund, one of its oldest and biggest backers, made a commitment in January 2011. Some of the money that KKR is managing in a separate account for Teacher Retirement System of Texas was allocated to the new buyout pool. In November 2011, Texas’s pension said it was committing up to $3 billion to KKR’s various funds over several years. KKR and employees also put $500 million of its own into the buyout pool.
Still, those commitments haven’t been enough as other big investors have pulled back from KKR and other firms. The Washington State pension, one of the largest private-equity investors, cut its allotment to KKR’s latest fund to $500 million from a $1.5 billion commitment to the firm’s 2006 pool. The Oregon pension has committed $525 million to KKR’s new pool, down from a $1.3 billion pledge for the prior fund.
The older fund ended its investment period during the third quarter, making Fund XI the firm’s primary investment vehicle for North American private-equity transactions, according to the statement. KKR has until February to complete fundraising, though it can ask investors for an extension.
The North American fund, which KKR has dubbed NAXI, ran into competition from its second Asia pool, according to Scott Nuttall, the firm’s head of global capital.
“A lot of our investors started to focus on the Asia II fund,” he said on a conference call today to discuss earnings. “We have a significant amount of overlap in terms of our investor base between those two geographic areas. And I think just given how their internal processes work, some of them decided to work on Asia ahead of NAXI.”
The firm is seeking $6 billion for the second Asian fund and has raised two-thirds of that, KKR said in its statement.
Of the investors in NAXI, 27 percent are new to KKR, contributing 10 percent of capital committed, he said.
“They tend to start out smaller when it’s a new relationship, so we’re seeing that dynamic a bit,” Nuttall said.
Larger backers have become more skeptical about the potential for outsized returns on mega funds. Returns have been below the industry average for funds larger than $4.5 billion raised since 2004, according to Preqin.
Some firms, including Blackstone Group LP (BX:US), have recognized investor appetite for smaller deals and are trying to shake the “mega” moniker. Blackstone’s president Tony James told reporters during a Oct. 18 conference call (BX:US) that the firm is avoiding large deals in its newest fund. The New York-based firm is promising to return more money to backers before taking its share of profits to attract investors into its private-equity funds.
The firm is doing that “because we suspect that fundraising will be more difficult going forward,” James said in response to a question from Bloomberg News. “There’s not the mindset that prevailed in 2006 and 2007 where you can raise money as fast as you can possibly put it out.”
In part to counteract the impact of shrinking investor appetite and a more competitive private-equity market, KKR has been expanding into other areas. Last year, KKR raised $1 billion to invest in growth companies in China, and has a $6 billion pool for Europe that it created in 2008.
Marc Lipschultz, one of KKR’s most senior partners, has been trying to build a business dedicated to energy and infrastructure outside of the firm’s main buyout unit. Besides the infrastructure fund, Lipschultz is also raising a pool dedicated to energy investments.
“Large firms are multiplying their regional, sector- focused and product-focused funds,” said Mounir Guen, head of MVision Private Equity Advisers Ltd., which helps firms raise money. “They are now excellent money-raising machines. They are raising on their long standing brand.”
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