Altoona State Case Write Up

Hamilton Wise: Altoona State Case: 9/17/2015

Question:  Should Altoona State consider the offer to reduce capital in Permira IV? How much would Altoona be giving up by accepting the offer? What would be the cost of the terms?

Factors to consider in evaluating the case:

1. Huge boom/bust period for PE firms culminating in a major slowdown in the number of transactions in 2008.
2. As a result of the economic downturn, many investors were overcommitted because their gradual draw-downs were not matched by a steady stream of distributions, leaving the investors to commit more capital than they initially intend upon investing.
3. Permira IV was at the time, the biggest recorded European Private Equity fund and the fourth-largest fund in the history of global private equity (11.1 billion euros).
4. Altoona had committed 100 million euros to Permira IV.
5. Permira, despite its great historical success, was unable to avoid the industry-wide downdraft, and in response to the inactivity, offered its investors the opportunity to reduce their capital commitments to Permira IV in an effort to solidify the long-term relationships of its funding base.
6. The specifics of that offer were:

1. LPs could reduce their commitments to 60% of the amount they originally pledged (52% of Altoona’s cash had already been called to the fund).
2. The total reduction was limited to 1.5 billion euros.
3. Any investor choosing to cap its commitment to the fund below the original amount committed would be required to pay management fees (1.35%).
4. Any investor choosing to cap its commitment to the fund below the original amount committed would receive only 75% of the distributions it would have received otherwise.

First, because Altoona committed 100 million euros to Permira IV and 52% of that was already called by the fund, Altoona could only reduce its capital commitments by 40 million euros. This falls under the 1.5 billion reduction limit given in the second bullet point contained in the offer. However, this means Altoona would have to pay approximately 1.35% management fees on its original commitment along with receiving only 75% of distributions. Therefore, by accepting this offer, Altoona would be giving up 25% of distributions from Permira IV. However, the 2008 financial crisis left these distributions in doubt as it is. Facing potentially five years of limited activity in the private equity sector, Altoona’s potential distribution pool would not be as lucrative as it would be in another time frame. Not to mention, Altoona has a significant over allocation problem, as many other private equity investors did in 2008. A 40% reduction in capital commitments during a period of large distribution drawdowns is definitely worth a consideration. In my opinion, despite the projected distributions at that point, the offer of a 40% reduction in capital commitments far outweighs any reasonable expected return from Permira IV following the 2008 crisis.