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WSJ Deal Journal

Are sovereign wealth funds a help to private equity investors, or a growing threat?

In these tight-fisted times, private equity firms have learned to love the rich flows of capital that come through sovereign wealth funds; many SWFs are big investors in private equity funds and have helped drive the fundraising boom of recent years. But those same sovereign wealth funds are putting their own money into deals, which means they could also be growing competitors to private equity firms.

SOVEREIGN WEALTH FUNDS

By the numbers:

Number of SWFs: 41Total estimated assets: $3.2 trillion

Total investment by SWFs in global M&A 2007: $48.5 billion

Percentage of all M&A this represents: 1%

Sources: analysis by Private Equity Analyst from various sources. A longer version of the analysis will appear in the April edition of PEA.

What few people know is that SWFs including the Government of Singapore Investment Corp. and Dubai Holdings, also have their own private equity arms that put money directly into deals. Singapore has GIC Special Investments, and Dubai Holdings has Dubai International Capital. More SWFs are expected to launch their own buyout units to get more profits directly without funneling rich management fees to private equity firms.

Which raises the question: Who will the SWFs first shop the deal to when they come across a buying opportunity? Their own private equity arms, or the outside funds they have long invested in?

A lot of money is at stake on the answer. Sovereign wealth funds are huge - $3 trillion in total assets by some estimates - and they’re setting their sights increasingly overseas. Of the $106 billion in cross-border investments made by SWFs since 1998, $99.3 billion were made after 2005, according to research firm Dealogic.

When the SWFs directly invest money in companies, they do some sizeable deals — though most of the larger transactions were done outside the U.S. Dubai International Capital, for instance, acquired health care services company Alliance Medical Ltd. of the United Kingdom for about $1.2 billion last year, and bought U.K. hotel chain Travelodge Ltd. for roughly $1.3 billion a year earlier.

Of course, it’s not the first time that we’ve seen these kinds of potential conflicts. Some Canadian pension funds have launched direct buyout arms. The $106 billion Ontario Teachers’ Pension Plan, for instance, is leading the $48.5 billion deal for BCE Inc., the largest buyout to date ever announced.

“PE funds and their investors are quite adept at handling potential conflicts,” said Yash A. Rana, a partner with Goodwin Procter LLP. They can co-invest in deals, he added, just as Ontario Teachers are teaming with Madison Dearborn Partners and Providence Equity Partners in BCE deal. “They recognize that nobody would win if they just bid up the price against one another,” Rana said.

Of course, given the backlash that has already materialized in some quarters against foreign investors in the U.S., the sovereign wealth funds are unlikely to act aggressively. “They consider all kinds of collateral consequences very very seriously,” said Bob Profusek, head of M&A at law firm Jones Day.