February 24, 2015
Interviewed by: David Snow
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PPM Smackdown: TKTK Capital

PPM Smackdown, Privcap’s game show-style program where real private equity experts apply real analysis to fictitious funds. Our experts pick apart the (fictitious) track record of (fictitious firm) TKTK Capital, a London-based mega firm that has been damaged by a string of bad deals and departures.

PPM Smackdown, Privcap’s game show-style program where real private equity experts apply real analysis to fictitious funds. Our experts pick apart the (fictitious) track record of (fictitious firm) TKTK Capital, a London-based mega firm that has been damaged by a string of bad deals and departures.

PPM Smackdown: TKTK Capital
Real PE Analysis, Fake PE Funds

David Snow, Privcap: Today, we’re going to talk about a legendary mega-firm that is raising a new fund called TKTK Fund VI. We will be going over the offering, the team and the track record of TKTK Fund VI and each of you will be revealing a due-diligence finding you have unearthed in your fictitious fiduciary duties in kicking the tires on this fund. At the end of our discussion, each of you will give a thumbs up or thumbs down to whether or not you would proceed toward a commitment to this fund. So, let’s hear first a bit about the offering of TKTK Fund VI.

TKTK Capital is a London-based mega-firm, founded in 1998. It has $60 billion in assets under management.

TKTK is seeking $8 billion for Fund VI. This is down from the $12 billion it raised for Fund V in 2008. It is also less than the $10 billion raised for Fund IV in 2005.

Fund V had to ask for an investment period extension as it struggled to put capital to work through the Great Recession. The new fund will continue TKTK’s pan-European investment strategy.

Snow: All right, now I’d love to get your initial reactions to the basic offering of this fund. Maybe starting with Tim, when you see the different numbers and the downsizing of the mega-fund and the fact that it struggled to put work through the Great Recession, does that immediately give you pause? Or are you willing to keep listening?

Tim Kelly, Adams Street Partners: No, I think everybody knows that the recession was quite dramatic across many different industries, private equity being one of them for sure. That isn’t as concerning to me as, or I should say, enough to close the book and put it away. I’m intrigued. They’re clearly doing something right. They have a lot of money under management. The concern for me, though—and it’s a bit of a contrarian view—is that I think LPs tend to look at growth in fund size as a risk in something that is problematic or requiring more diligence to get your arms around. Equal to me is the concern of downsizing, because of the effect on job security and decision-making if one doesn’t necessarily know how the impact of a falling capital size is going to affect him or her on the team.

Andrea Auerbach, Cambridge Associates: It’s intriguing and, clearly, if they’re on Fund VI, I have to believe that my firm in this fictitious world would have met with them in Funds I through V. So, I’d probably have some sense of the context that led to the moment in front of us right now. They obviously took in too much capital at the wrong time and I’m also very curious as to what are the investment period extension terms. What types of concessions did they make to allow them to extend their investment period? What did their LPs get—that was a real moment to reassess and realign the firm with its investors in terms of, “This is what we are going to do going forward. We acknowledge that we have too much capital to deploy within the timeframe you originally gave us.” So, there’s a lot of alignment information lurking in this brief that you had given us.

Steven Costabile, PineBridge Investments: I’d say that the firm was founded in 1998, so they’ve already gone through one crisis. But, in that timeframe of 2000, 2001, 2002, they were probably much smaller. So, obviously, they went through that period very well to get to the size they are. But again, on a different construct—they were smaller then. Obviously, in this downturn in’08 and ’09, they didn’t handle it so well. This is a firm that’s probably trying to figure out exactly who they are, trying to reposition themselves. I do say it’s a positive that they’re reducing in size, but, to Tim’s point, it is extremely disruptive.

The key is how they’re handling that. Have they let go a lot of partners? Do they still have the core people that started the firm? Are they essentially saying, “Look, we were at 12. It didn’t work. We were at 10, it didn’t work. Eight is the right size and now, we’re essentially overstaffed to execute on this eight.” [There are] a lot of questions there; it’s not generally a positive. Again, I wouldn’t shut the book yet either, but we’re starting out of the gate with a lot of questions.

Snow: Let’s move on to learning more about the team of TKTK Capital. TKTK’s two co-founders are legends in the private equity industry and still solidly at the helm of the firm.

In the past three years, several senior partners have left TKTK to either retire or start their own considerably smaller private equity firms. An office in Shanghai has been shut down to streamline operations. An office in Budapest has also been shut down. The firm recently promoted 15 professionals to partner.

Kelly: There’s so much change here. I’m not one who looks at just necessarily departures being bad. Sometimes departures can be good. It can be a nice, cleaning out of old wood or slow wood; however you want to characterize it. But when you see the closing of offices and the departure of partners, when you see promotions—what’s going on here organizationally?

Snow: Promotions aren’t a good thing? Isn’t that incentivizing the younger generation?

Kelly: No, promotions can definitely be good. I need to understand more: were they a proactive and necessarily part of the firm’s growth and talent development plans? Or was this a gun to the heads of the co-founders in the sense that there’s a lot of change going on?

Auerbach: I often think of private equity as a guild industry, which is dominated by first-generation entrepreneurs. And we’re heading into this zone now in the industry where a lot of these first-generation founders need to start thinking much more about their legacy than maintaining a tight grip perhaps on their firm. And if you’re not growing your next generation of leadership now, you’re not going to have any leadership when you don’t want to be running your firm anymore. So, I view that as—when I saw that fact, it’s like, how old are these guys? Give us a sense for their leadership style. That also made me think, “Who is on the investment committee here?”

Other signals that I look for are, why did these senior partners leave? Did they call in wealthy? Did they vote with their feet because it was clear they weren’t going to get to truly run the firm in a way, perhaps, that they were expecting?

The other questions I had were [about] the GP commitment. If you have two founders clearly at the helm of a mega-fund, what exactly is this fund committing to its own funds, to eat its own cooking? Because if you’ve been that successful over this period of time, I would expect to see a healthy GP commitment, especially if some of your senior lieutenants have left. Let’s pony up on to the table and reinvest in your own success.

Costabile: Usually, what happens is these founders go higher and higher up and they’re at a 100,000-foot level. It’s hard to reinsert yourself into a process after all those years of elevating. I think that’s troubling. Moreover, it seems to me the two founders lost control of the firm. Right? Where the departing partners have essentially voted with their feet that they do not think that the firm can raise $8 billion, right?

Snow: Now, let’s talk about the track record of TKTK Capital.

TKTK’s recent track record has been mixed, to put it mildly. While the performances of Funds I through III have ranged from spectacular to strong—always placing in either the top quartile or above average—the $10-billion Fund IV is challenged, showing a net IRR of 3%, placing it in the bottom quartile of 2005 vintage funds. The fund had three portfolio company bankruptcies.

TKTK explains in the PPM that the failure of the three portfolio companies has to do with “unprecedented market developments and overleverage.” The firm says it has changed its investment committee process to avoid similar missteps.

TKTK’s most recent Fund V has had only two exits—both IPOs that have yet to return capital. The fund has returned some capital, thanks to dividend recapitalizations.

The PPM claims that Fund V is on track to deliver a very strong performance. TKTK says it sees amazing opportunities to put a new $8-billion fund to work and it has a highly experienced and well-resourced investment team to execute on those opportunities.

Costabile: It’s really complicated and difficult because if, in fact, we just focus on Fund V and say, “Let’s look for something underneath,” obviously there’s a lot of unrealized here. But it’s a 2008 fund. The time-value money is working against this fund already and, with only two exits, the interim performance of the unrealized is going to have to be spectacular. But now, you still have an issue, because if you look under the hood and find out that these portfolio companies are doing okay or well, the very guys that did the deals may not be there anymore because they’ve left.

Auerbach: Looking at this, they explained that the failure of three companies had to do with unprecedented market developments. Okay, give you that and over-leverage. That’s like saying, “The leverage made me do it, officer. I didn’t have a choice. I had to do the leverage.”

Snow: I was over-served leverage.

Auerbach: I was over-served with leverage. Yeah. So, I’d tend to not give too much credence to that. Also, thinking about this exit route—they’ve only had two exits in this fund, both IPOs. Does that mean your investments are too big to trade? Because if you’re a mega-fund, there’s no one above you in the food chain. So you may not have as much access to generate an actual realized return as we might like to see. We always like multiple exits, multiple options for exit, and it may be implied here that they don’t have multiple options. That’s also concerning.

Snow: Tim, what’s your take?

Kelly: In a few words, this appears to be a bleeding animal. I mean, it seems to be wounded in some way and it’s just a matter of where it is wounded. It seems like, as we’ve talked about, the fracturing of the team, the dominance of the co-founders, is seeping through and showing up in the results here. Six funds—clearly their longevity is a credit to the founders in some way. But, also, I think it’s a weakness in so far as…there is a human tendency…to look and say, “There is something here.” Because they had three really top-performing funds. What’s going on? Can they get back there?

Snow: But wait, there’s more! Because it’s time for invasive due diligence, where each of you is going to reveal a fictitious due-diligence finding based on your fictitious due diligence. Of course, as professional investors, you don’t just base your decisions to commit or not commit solely on what’s in the PPM. You have to do your own tire kicking. Each of you has done this for TKTK. Andrea, you can start by revealing your due-diligence finding.

Auerbach: Sure. My fictitious due-diligence finding was that half of the LPs from Fund IV not re-upping for Fund VI.

Snow: All right. Does it matter what the other kids think? Or can you just make up your own mind based on the merits you see before you? Does it trouble you that half the LPs are not coming back?

Auerbach: Well, gosh. I would say a couple things. Investors need to think about developing their own programs in a way and in a profile that makes the most sense for them and their goals, right? This is helpful information, but ultimately, for a client building a portfolio under certain circumstances, they’ve obviously got to view things through their own lens. So, we’ll just put that on the table for a start.

The second observation I would have is [that] this is not particularly unusual in terms of a rotation of LPs. Once funds pass through certain sizes in terms of how much capital they aggregate, there does almost seem to be a natural rotation of maybe earlier investors who have more confidence or conviction around funds investing less capital because it will, in fact, achieve better returns.

Costabile: I looked at this the other way. I mean, yes, of course, half the LPs from Fund IV aren’t going to re-up. They didn’t do very well. The other side was, why would half of them agree to go into the new fund? Right? I’d want to call them and say, “Okay. Wait a minute.”

Auerbach: The glass is half-full?

Costabile: Right, why is that? The glass is—what am I missing here? It would be pretty apparent that why you wouldn’t re-up here? Yet we have half the LPs from Fund IV, a sub-optimal fund. And, assuming they’re in Fund V as well, they must see a lot of efficacy in Fund V to re-up. So, I’d want to know the profile.

Snow: Tim, you have due-diligence finding number two. Can you please let us know what you discovered?

Kelly: I discovered that one of the two founders of TKTK recently made an investment in an investment group that purchased the Premier League Soccer Team.

Snow: That’s fun for him. What could possibly be the downside of something like—?

Kelly: If this were an only data point, it might not raise the red flag a bit higher in my mind that there’s organizational issues going on here. But…we all know that private equity, especially for GPs, is a wealth generator. There are opportunities that come with wealth generation, such as being able to pursue hobbies or interests you have outside your day-to-day focus. That being managing the fund on behalf of your investors. That doesn’t necessarily bother me, whether it’s a soccer team today or a yacht tomorrow, whatever it might be. But the old adage with all I getting, get understanding, B.C. Forbes old adage. I’d need to understand a bit more here about the individual himself, to spend a little more time with him or her. The reason being is, is he or she now migrating and their point in life is wanting to just have some hobbies? Is this fund, this firm, nothing more than another soccer team to them in the sense that it’s a hobby?

Auerbach: To me, I just sit there and say, “What’s the GP commitment?” You bought a team so you have something like—

Snow: If you put a hundred million in the team and 25 in the fund, right? That’s a problem.

Auerbach: Red flag. Yeah.

Snow: Steve, why don’t you reveal your due-diligence finding?

Costabile: Yes. On my fictitious due diligence, I found that TKTK’s valuations and reporting throughout economic and fundraising cycles have been remarkably detailed, timely and accurate.

Snow: So, what this might allude to is if there was an exit at a billion-dollar valuation, the last place they marked it was roughly near one billion. And that didn’t change whether they were fundraising or not fundraising. Does that give you a certain form of confidence in the integrity in the way this firm reports and values their investments?

Costabile: It may. And maybe it’s simply confirming that the returns haven’t been very good and they’ve reported them as not being very good. So, it really hasn’t moved the needle for me.

Snow: Thank you for accurately reporting that I’m in the bottom quartile.

Costabile: Exactly. So, certainly, this would be helpful.

Snow: Andrea or Tim, do these guys get extra points for having a rigorous and accurate valuation process?

Auerbach: I look forward to getting the announcement that their CFO has left to join another firm because, apparently, their CFO has very good processes in place and now they can leave and go on to greater success potentially sometime in the future.

Snow: I think we can move now to the moment of truth where each of you reveals whether or not you give a commitment to TKTK Fund VI—a thumbs up or thumbs down. Of course, including all the caveats that this is a real opportunity in the real world, it’s more complicated than this. But, staring with Steve, thumbs up or thumbs down for this fund?

Costabile: I have to say no. Just [in] the facts as they’re presented—there are just too many negatives for me to want to have exposure to the potential upside based on all these negatives that are right in front of me.

Snow: Andrea?

Auerbach: Maybe if they were to change their fee-and-carry structure and up that GP commit that I’ve been sticking on, it might be worth more of a look other than a browse. But I would say I’m a pass for now.

Snow: Tim?

Kelly: The organizational dynamics suggest no, but I would try to get to know some of those 15 new partners or some of the partners who have left, trying to figure out if there’s an element there of who generated the value in the first three funds. Is there something to take advantage of here? Maybe not in Fund VI, maybe not with this firm, but there’s seemingly a lot of talent there that you might want to get to know.

Snow: Maybe you could back a spin-out and form a totally new firm.

Kelly: Exactly.

Snow: Great. That’s three no’s for TKTK Capital. You’ve broken the hearts of two industry legends, but I guess that’s your job, so thank you for joining me for this segment of PPM Smackdown.

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