Friday, July 26, 2013
Cambridge Associates U.S. Private Equity and Venture Capital Commentary Quarter and Year Ending December 31, 2012
On the heels of a strong finish in 2011, U.S. private equity and venture capital funds also performed well in 2012, due in large part to double-digit returns in most of the large sectors in both asset classes. In the four years between 2009 and 2012, private equity funds had positive returns in all but three quarters and venture capital funds rose in all but two quarters, as indicated by the Cambridge Associates LLC benchmark indices of the two alternative asset classes. During the fourth quarter of 2012, both private asset classes bested large cap public equities, but for the year, venture capital trailed public equity returns and private equity funds had mixed success against the public equity indices.
Over the past ten years, private equity significantly outperformed venture capital and the public markets, while over that same time period, venture slightly underperformed public indices. Returns for the Cambridge Associates LLC U.S. Private Equity Index® and Cambridge Associates LLC U.S. Venture Capital Index® were positive in the fourth quarter of 2012 while most public equity indices were negative. Macro factors impacting the public markets were largely political, such as the “fiscal cliff” negotiations, and overall market uncertainty had a dampening effect on initial public offerings (IPOs).
Highlights of the fourth quarter and year are:
_ With the exception of the one-year period, the private equity benchmark outperformed large and small public companies in all of the time periods ending December 31, 2012 listed in the table above. During various periods over the past ten years, the venture capital index’s record against the public markets has been mixed but over the long term, venture has significantly outperformed public equities.
_ The spread between the private equity and venture capital ten-year returns is down to 7.2% after hitting a peak of 12.7% at the end of the third quarter 2010. _ As of December 31, 2012, public companies accounted for about 18.6% of the private equity index, a decrease of approximately 2.0% from the third quarter. Public company representation in the venture capital index decreased to 11.8% from about 14.9% last quarter. Non-U.S. company exposures in both private asset class indices rose a bit in the fourth quarter. In the private equity index, it went up approximately 0.8% to 19.7% and in the venture capital benchmark, it increased 0.3% to 10.8%.
Private Equity Performance Insights:
During the fourth quarter of 2012, most U.S. public equity indices were down amid economic and political uncertainty regarding the “fiscal cliff.” The Cambridge Associates LLC U.S. Private Equity Index®, however, remained in positive territory for the second consecutive quarter and the third of four in the year. The index’s fourth quarter return was 3.5%, bringing its return for the year up to 13.8%, an increase of about 2.2% from the previous year. In the fourth quarter, portfolio company valuations increased across all vintage years from 2000 to 2012; funds launched in each of the five vintages that represented at least 5% of the index saw asset values improve by at least $1.3 billion. In dollar terms, valuations grew most for consumer, healthcare, energy, financial services, and manufacturing companies; all were among the index’s large sectors.
According to Dealogic, 12 private equity-backed companies went public in the fourth quarter at a value of $3.6 billion; the number of companies equaled the third quarter’s activity but the value represented an increase of $1.9 billion. During 2012, 61 private equity-backed companies went public, fetching $12.7 billion, and while there were 13 more IPOs than in 2011, the value of the deals was roughly half. Some of 2012’s better known IPOs included Bloomin’ Brands and Realogy (which includes real estate brands Coldwell Banker and Century 21 among others). The latter represented almost 10% of the value raised by IPOs during the year.
Both the fourth quarter and year were active periods for mergers and acquisitions (M&A) involving private equity-backed companies. There were 237 M&A transactions in the fourth quarter, up from 199 in the third. The values of 70 of those deals were disclosed to the public, which is in line with the previous quarter’s 71. Based on the publicly available values, the average transaction size rose from $224 million in the third quarter to $562 million in the fourth. In 2012, there were 806 M&A transactions, an increase of 115 over the prior year. The values of 279 deals were disclosed to the public in 2012 at an average size of $291 million. In 2011, there were 245 transactions with publicly-disclosed values worth an average of $362 million.
Five vintage years -2007, 2006, 2005, 2008, and 2004 - represented nearly 82% of the private equity index’s value by the end of 2012; the index has grown more concentrated since 2010 when there were seven vintage years of note in the index. Returns among the five vintages were slightly better in the fourth quarter than they were in the third, ranging from 2.2% for the 2004 funds to 5.4% for the 2008 funds. Throughout 2012, an active M&A environment and generally strong public markets helped drive realizations and bolster unrealized valuations.
During the fourth quarter and year, in funds raised in the 2007 vintage year, write ups in the consumer and energy sectors combined to account for roughly 40% of the vintage’s increased valuations. In the second largest vintage year, 2006, retail and healthcare led all other sectors with respect to valuation increases, representing more than 70% of the write-ups in the fourth quarter and more than 50% for the year. For the year’s best performing vintage, 2005, consumer sector portfolio companies jumped the most in value but healthcare and IT businesses also contributed. Energy sector write-ups were by far the largest in the fourth quarter’s highest returning vintage, 2008.
All Eight Key Sectors in the PE Index Earned Positive Returns for the Quarter, Consumer Led All
All of the eight sectors that represented at least 5% (“meaningfully sized”) of the index produced positive returns during the fourth quarter of 2012. The three largest sectors – consumer, energy, and healthcare – comprised more than 51% of the index’s total value and returned between 4.1% and 6.7%. On a dollar-weighted basis, the three earned a gross return of 5.5%, outperforming the total benchmark gross performance by 0.7%. Among the eight meaningfully-sized sectors, consumer posted the highest return for the quarter; the 2006 and 2007 vintage years contributed most to the performance and they accounted for more than 52% of the sector’s market value at the end of the year. Media produced the fourth quarter’s lowest return, 0.9%, which was driven mostly by modest valuation moves (both up and down) in all vintages except for 2004 and 2008. During the quarter, fund managers allocated more than half of the capital invested to energy, consumer, and healthcare companies – about 3% higher than the historical average.
For the year, manufacturing was the best performing sector and media was the worst. Write ups for manufacturing companies in vintage years 2007, 2004, and 2006 were the largest drivers of that sector’s return. The 2004 vintage was the largest positive contributor to the annual performance for media, the only large sector that did not produce a double-digit positive return for the year. The three largest sectors – consumer, energy, and healthcare - outperformed the benchmark’s total gross return by 0.2% and outperformed all other industries by 0.4%.
Distributions Hit a Record Level; Capital Contributions Also Rose
In the fourth quarter, managers in the U.S. private equity index called about $25.2 billion from limited partners and returned $48.6 billion; these represent a 46.3% increase in contributions and a 122.6% increase in distributions from last quarter. The increase of nearly $8.0 billion in capital calls from the prior quarter was the largest quarter-over-quarter rise since the second quarter of 2010. Distributions increased by nearly $26.8 billion from the third quarter, hitting the highest quarterly level seen in the 27 years that Cambridge Associates has tracked the industry.
Investors in funds launched in 2007, 2008, and 2011 contributed $17.9 billion, or 71% of the total capital called during the quarter, the 2007 funds alone represented $9.7 billion, or 39% of the capital called. Conversely, each of the vintage years between 2004 and 2008 distributed more than $4 billion in the quarter. Investors in funds launched in 2006 and 2007 received approximately $22.8 billion or 47% of the capital distributed. Distributions outnumbered contributions in all quarters in 2012. During 2012, managers in the U.S. private equity index called $71.3 billion from limited partners, more than $10.0 billion less than they called in either 2011 or 2010 but 43% more than in 2009. Total distributions during 2012 hit $118.0 billion – the largest annual amount since the index’s inception. Distributions increased by 23% over totals hit in 2011, 59% from 2010, and 327% from 2009. Exits and recapitalizations helped drive distributions to record highs. Friendly credit markets enabled recapitalizations and anticipated tax hikes made motivated sellers out of some private equity investors. Last year was the second in a row but only the fifth since the inception of the private equity index in which distributions outpaced contributions; the others were 1996, 2004, 2005, and 2011. From 2006 through 2010, when contributions outnumbered distributions, private equity fund managers in the index called 1.3 times as much capital as they distributed; in 2011 and 2012, the reverse was true, as distributions outweighed contributions by a similar margin.
Venture Capital Performance Insights
For the first time in three years, the venture capital index produced a single-digit annual return, coming off of two consecutive years of 13%+ performance. Dragging down the index’s performance for the year were returns of less than 1% in the middle two quarters and just over 1% in the last. Middling performance from the index’s largest sector, IT, contributed heavily to the benchmark’s result. The IPO market, active during the first half of the year, struggled in the second half following disappointing Facebook IPO results. Contributions were lower in 2012 than in 2011 while distributions increased, and distributions not only outpaced contributions for the year but they hit their highest annual level since 2000.
According to the National Venture Capital Association (NVCA) and Thomson Reuters, 49 venturebacked companies went public in 2012 for a total IPO offer value of nearly $21.5 billion. The number of venture-backed IPOs was in line with 2011, however the total offer value was up significantly, thanks entirely to the $16.0 billion Facebook IPO. There were 469 venture-backed M&A deals in 2012, down slightly from 2011 with 498. For deals with values disclosed to the public, the average size of a venture-backed M&A transaction was up 21.7% from 2011, to approximately $173.6 million.
Fourth-Quarter VC Performance Mediocre; Solid Overall in 2012
After beginning 2012 with a strong first quarter, the Cambridge Associates LLC U.S. Venture Capital Index® returned 0.6%, 0.6%, and 1.2%, respectively, in the second, third, and fourth quarters, ending the year with a 7.2% return. All but one of the meaningfully-sized vintage years had flat or positive returns in the fourth quarter with the exception being vintage year 2000; and all were up for the year (see table to the right). The fourth quarter performance was driven by the five vintages that each made up more than 10% of the index; vintage years 2000 and 2005 through 2008 vintage years together comprised over 64% of the index. Despite mediocre fourth-quarter performance, all seven of the meaningfully-sized vintage years earned positive returns for the year, led by the 2000 and 2010 vintages. Significant write-ups in software, IT, and healthcare companies were behind the positive performance for these two vintage years. Software was by far the largest contributor to the 2000 funds return while IT led in the more recent vintage, 2010. The once dominant vintage year 2000 represented only 11.2% of the index in 2012, down from roughly 13.0% the year before and a peak of over 40% in June 2005.
Software Posted the Highest Fourth Quarter and Annual Returns in 2012
The venture capital index remained concentrated by sector, with the three largest – IT, healthcare, and software – accounting for nearly 76% of the index’s value. With totals slightly higher than their long-term averages, over 81% of capital invested during the fourth quarter went into companies in these sectors. IT and healthcare companies garnered more than twice the dollars allocated to software. Among the large sectors, software was the best performing during the quarter, posting a 3.5% return, while media’s - 3.7% was the lowest. Write-downs in media investments in funds raised in 2000 and 2005 were not offset by smaller write-ups in other vintages.
For the year, the three largest sectors returned over 11.9%, outperforming the total 2012 return for all portfolio companies by over 2.2%. Software companies earned a gross return of 23.0%, by far the best among the top three sectors. Vintage years 2000 and 2008 contributed the most to the sector’s strong return. On a pooled, dollar-weighted basis, software companies produced double-digit returns in vintage years 2000 and 2005 through 2008.
VC Calls and Distributions Increased Slightly from Prior Quarter Levels
In the fourth quarter, managers in the U.S. venture capital index called just under $3.4 billion, an increase of $171 million, or 5.3% from the previous quarter. Distributions also rose from the third quarter to the fourth, albeit by only 2.9%, to $6.1 billion. This marked the fourth consecutive quarter that distributions outnumbered contributions. It has been more than 12 years since there was a similar trend in LP cash flows.
Managers of funds raised in 2008, 2010, and 2012 called approximately $1.7 billion or 50.0% of all capital called during the quarter. Each vintage called more than $500 million. Investors in the 2000 and 2004 vintage years each received over $1.0 billion in distributions or 44.2% of the total distributed. Vintage years 2005 and 2006 both distributed more than $600 million in the quarter. Managers in the U.S. venture capital index called less and distributed more capital in 2012 than they did in 2011. Contributions decreased 12.2% to $13.7 billion while distributions increased 50.5% to nearly $22.2 billion. Distributions in 2012 were the third highest annual total of all-time, behind only the bubble years of 1999 and 2000.