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Believing in buyouts

The situation at PAI does not signify wider large cap woes, writes Toby Mitchenall.

PAI Partners – the Paris-based buyout firm – is locked in talks with its limited partners that could see its latest fund either slashed in size or wound down altogether. Is this symptomatic of a general LP retreat from the large buyout market, or is it more complicated than that?

The surprise replacement of chief executive Dominique Mégret, a 35-year veteran of the firm and chief executive since 2006, triggered a key man clause in the limited partner agreement of the €5.4 billion vehicle. As such, the fund’s 130 LPs have the option of suspending investment, reducing their commitments or closing the fund altogether.

A letter from the new chief executive Lionel Zinsou to LPs in September offered the chance to reduce undrawn commitments to the fund by 50 percent, potentially reducing the total pool of investment capital to €2.7 billion.

The reason for this offer, wrote Zinsou, was that funds committed in 2007 had to be “sensibly reduced in 2009”. Curiously, Zinsou’s letter to investors said that in summarising the interests of various different parties, a reduction of between 20 percent and 40 percent was mooted as an “agreeable” range. However, a larger reduction was being offered because “building a consensus requires to go beyond the majority needs and wishes”.

The rationale behind “right-sizing” of a fund in this way makes sense, even if it will result in a potentially painful reduction in fee income. In 2009 and immediately beyond, low entry valuations mean – broadly speaking – smaller deals than in 2007 and hence less capital needed for the same number of investments.

This phenomenon led one advisor recently to note that “€6 billion will be the new €11 billion” when the fundraising for large cap private equity funds finally recommences.

And then there are the various liquidity pressures on LPs, which mean that many would welcome a reduction in uncalled commitments. Precedents have already been set by Permira and TPG in scaling back funds under these conditions.

It is surprising, however, that PAI would offer such a dramatic cut when somewhere between 20 and 40 percent would apparently do the job. 

Elements within PAI’s LP base are reportedly unhappy even with a 50 percent cut. According to a report on Reuters, the Canadian Pension Plan Investment Board (CPPIB) has asked fellow investors in the fund to reject the offer as inadequate. CPPIB had emailed other LPs saying it is working on an alternative proposal, the newswire reported, quoting a source familiar with the matter.

It could be tempting to read the situation at PAI as being indicative of a wider market trend; that LPs want out of the large buyout space – which has been stunted by the credit crunch – and a key man clause provides an ideal get-out-of-jail-free card.

This could, however, be an over-simplification of the situation. Looking at the sequence of events, it seems likely that concerns at PAI go beyond a general LP dissatisfaction with the large buyout space.

Earlier in the year the firm suffered the loss of its investment in roofing business Monier, in what was one of Europe’s most closely followed restructuring processes. Then Dominique Mégret, the man who had been at the firm’s helm during fundraising in 2007, was replaced in what several insiders have described as acrimonious circumstances. The new chief executive subsequently extended to LPs an offer, not just to trim the fund, but to cut it in half.

As one prominent European LP recently noted, the large cap buyout space is not dead. Far from it. The large cap space is populated by some of the most experienced firms in the business, and while some firms have their individual issues to deal with, many will go on to raise more capital and with it generate good returns.

Key man issues at one large buyout firm may have given LPs pause for thought, but that does not mean they will be evacuating the scene en masse.