Forced evolution

Up to half of Australia’s existing private equity firms may find they are unable to raise a fund when they launch their next road shows. That was the prevailing sentiment voiced by industry insiders during a recent visit to Sydney.

The strain is already being seen. This time last year there were around nine Australian and New Zealand firms out fundraising: CHAMP Private Equity, Anchorage Capital, Tasman Capital Partners, Direct Capital, Propel Investments, Mainridge Capital, Pinnacle Private Equity, Harbert Management Corporation and Gresham Private Equity.

By August 2010, only three had come close to final closes: Sydney-based CHAMP had collected A$1 billion by April and anticipated hitting its A$1.5 billion by the end of September; New-Zealand focused Direct, which closed its fourth fund on NZ$325 million (€168 million; $226 million) in February; and special situations-focused Anchorage, which in April closed its first fund on A$200 million.

Of the others, some are still working on reaching a first close, like Tasman, while others, like Gresham, have suspended fundraising for the time being.

Difficult fundraising conditions have been a global reality since the onset of the credit and financial crises, however in Australia the fundraising environment has been dulled further due to diminishing appetite from both the local superannuation fund industry and foreign LPs.

Although the superannuation industry allocates a relatively small percentage of assets to private equity – averaging about 1 percent – compared with North American and European pension funds, it is still the most important source of capital for Australian private equity fund managers, especially lower mid-market firms. According to the Australian Bureau of Statistics, superannuation commitments accounted for 56 percent of total funds committed to Australian private equity funds in 2008 and 2009.

However, this heavy domestic play has not always been in the best interests of the super funds.

 “Super funds would back say six [Australian] firms and find that not only were they all bidding on the same assets, but they would often club together on deals too… Not quite the diversification they were looking for,” one GP explains.

Waking up to their home bias, super funds are now seeking global private equity diversification.

Australian firms are facing a doubly constrained fundraising environment

At the same time, foreign LPs, which have been the main capital providers to firms investing at the larger end of Australia’s buyout market, may also be reconsidering their options.

As one GP points out, when a big institutional investor in the US is forced to review its global private equity allocations, Australia is an easily expendable market. Another GP source adds: “No LP ever got sacked for not doing Australia – it’s not a ‘must-do’ market.”

A traditional selling point of Australian private equity has been that it is geographically part of Asia, but doesn’t share many of the risks and uncertainties that come with investing in the rest of the region. As such Australia has become an Asia proxy in investment terms.

While this still stands, many surveys have also recorded the greater willingness of LPs globally to invest directly in China and India and the greater inflows of capital being seen there as a consequence.

 “In the last capital-raising cycle there was a lot of attention on Australia as a foothold to Asia. This time around the interest has moved onto Asia itself,” comments one placement agent.

All of this means Australian firms are facing a doubly constrained fundraising environment.

And with several firms including Ironbridge, Crescent Capital, Quadrant Private Equity and Advent Private Capital thought to be only a deal away or so each from going back to market, the tests will keep coming for the industry.

Clearly, Australia is still a good place to invest money – the economy is growing and, while it may only be 2 percent of the world’s GDP, it is considerably more than 2 percent of the world’s investable universe. However, in the post-downturn environment it will be a case of survival of the fittest – and, based on portfolio performances coming out of the recent downturn, most insiders are pretty clear on which firms make the cut.

 “If there were a dozen managers, then there are six who have jostled themselves into a go-forward position. Then there are the six who are not credible competitors to good firms anymore,” commented a fund of funds manager.

As Darwinism slowly sets in, and LPs vote with their feet, the landscape of Australia’s domestic private equity market will evolve dramatically.