Private-equity firms staking future on piecemeal sales

Large private-equity firms are selling slices of their companies bit by bit, diversifying away from the traditional model of 10 guys in a room yelling at one another.

Before this summer’s credit crunch closed the spigot of liquidity which had fueled buyout deals, there were a number of transactions in which private-equity firms sold pieces to institutions and the private and public markets.

The Carlyle Group of Washington on Sept. 19 sold a 7.5% stake to Mubadala Development Co., an investment firm owned by the Abu Dhabi government. The California Public Employees’ Retirement System in Sacramento also owns a 5.5% stake in Carlyle that it purchased in 2001.

Apollo Management Co. of New York sold close to a third of its shares, selling a 12.5% stake for $828 million at $24 a share on New York-based Goldman Sachs & Co. Inc.’s private ex-change Aug. 3, and in July selling a 10% stake to CalPERS and another 10% to the Abu Dhabi Investment Authority, for a total of $1.2 billion.

Oaktree Capital Management LLC of Los Angeles raised $828 million in May when it sold a 15% stake on Goldman’s private exchange, the Goldman Sachs Tradable Unregistered Equity system. 

And all that selling came on the heels of action even earlier in the year, when the Abu Dhabi Investment Authority bought a 15% to 20% interest in Ares Management LLC of Los Angeles for $375 million.

Also this year, The Blackstone Group of New York raised about $7 billion selling a 9.9% stake to the Beijing-based China Investment Corp., and another 12.3% in an initial public offering.

Private-equity firms are raising capital to smooth succession and to add investment strategies, said Monte Brem, chief executive at StepStone Group LLC, a private-equity consulting firm in San Diego.

“Potential benefits from these investments include access to capital that can be used to further institutionalize and expand the capabilities of the firms, and assist in their succession planning,” he said.

Most large firms still are run by their founders, noted Donn K. Cox, managing director  of Sacramento-based private-equity consulting firm LP Capital Advisors.

The few founders who have passed the torch have walked away from their firms without reaping a cent of the firms’ residual value, private-equity ex-ecutives and consultants said.

“In the current market environment, there is a lot of pressure to sell portions of the firms as the founding partners are looking to transition the firm to the next generation of leaders,” Mr. Cox said. “It gives liquidity to the founders, the people who built the business, and hopefully steers a greater portion of the carried interest to the investment team.”

The capital infusions also allow the firms to develop new investment strategies. General partners are trying to diversify into multiple-line megafirms, and they need the operating capital to reinvest, Mr. Brem said.

In Carlyle’s case, its partial sale to Mubadala Development will allow executives to expand the firm’s investments, said Carlyle spokesman Christopher Ullman. The sale also creates a long-term in-vestor in Carlyle funds, he said, noting that Mubadala executives already have agreed to commit $500 million to a new Carlyle fund.

The 5.5% stake Carlyle sold to CalPERS in 2001 for $175 million is worth close to $1.5 billion today.

“At that time … Carlyle was positioning itself as a leader in private equity. Long-term, as an equity owner of the firm, we stood to gain insight into the industry and build global presence from their experience,” said Clark McKinley, spokes-man for the $246.6 billion public-pension fund.

CalPERS executives also in-vested in Apollo and, in 2001, in TPG Ventures Inc. of Menlo Park, Calif., for the same reasons.

But there are clear disadvantages to changing private equity’s fundamental-investment model.

“Some of the concerns that these investments and subsequent public filings raise are that they could in-crease the firm’s focus on growth in assets under management and short-term earnings, and potentially dilute the historical alignment of interests between general and limited partners,” Mr. Brem said.

Mr. McKinley said CalPERS officials have “a lot of confidence” in long-term partners Apollo and Carlyle. “The performance results of their funds explain why we do.”