Comments

Outrageous - and $100k / year outclassed working stiff government bureaucrats chasing them with outdated regulations.

Posted by Sean at March 9, 2006 1:51 PM

Tom, I read that earlier in the week too. They target public companies which Wall Street has lost interest in (like my old employer Gartner) or whose management cannot deliver what the street wants. Is it much different that card companies or insurance companies charging more for higher risk? Sounds sickening but that is our capitalism at work, since these funds have to compete for capital with VCs and hedge funds - they have to return similar results...the elephant in the room is the question - are we letting investor interests (broadly) trump consumer, societal and other equally important interests.

Posted by vinnie mirchandani at March 9, 2006 1:54 PM

Vinnie, my concern (and, Sean, I'm not suggesting legislation) is that the quick cash takeout makes it almost a sure thing that the purchased company won't be able to fix the problems that caused Wall Street to turn down the lights to begin with. Also, if you believe the article, there must be some way to cap the apparently common "management" fees.

I guess I was taken aback by this, and how apparently widespread it is, because I'd seen the private equity boom as a collective boon for the purchasees (and thence the economy). Of course as you say, the rape and pillage which generates the quick-hit returns induces more and more marginal players to get in on the action. Ka-ching.

Posted by tom peters at March 9, 2006 2:51 PM

I have been sprouting similar information regarding these type of buyouts. In his book, "Crisis Investing for the Rest of the 90's" by Douglas Casey, Casey made a case for this type of "investing" and how "management" - under the current rules - will always win with quick returns over 10 years ago. Thanks for alerting us to the Forbes article - as Doug's quote was starting to wear thin with his early 90's (pretty correct) prediction - I now have something else to use in arguments relating to this.

Posted by ovlas at March 10, 2006 1:39 AM

Part of what seems so troubling here is the sense of greed run amuck and a perception that there are victims. There is no real debate about the avarice side of this equation. But Tom, who are the victims? Please don't interpret my question as an indication that I don't believe there are any--if there are true victims, I would love to file lawsuits against the greedy. Maybe litigation is the answer if legislation is not. But if someone invests in a company taken public after being stripped bare by private equity holders, are they victims are just guilty of not reading the fine print on the company they invested in?

Posted by Patrick Lamb at March 10, 2006 8:23 AM

Free market rules apparently - maybe the Internet explosion of information makes people make better decisions and avoid ka-ching victimhood - then again the smart get smarter and shady gets shadier faster perhaps.

Posted by Sean at March 11, 2006 3:19 PM

This article is either very poorly researched or deliberately misleading in order to create shock value. It is also surprising that such weak logic found its way past the editorial team at Forbes. Here are just a few examples of this questionable reasoning .

1.The implication that one Private Equity firm would buy a business off another at an inflated price in order to help the former make a good return. Private Equity is a highly competitive industry not just in acquiring the best assets but raising finance from investors. If your competitor achieved a higher return than you on the last fund, your investors are likely to desert you and invest in his fund next time. These Secondary Buyouts only occur when the buying firm has conducted extensive due diligence to ensure that the asset is a healthy, well-invested business with growth potential. No sports team would give its rival its best players in order to help its rival look better.
2.The implication that you can strip an asset bare and then just dump it on the public market via an IPO. The road to an IPO is one of the most rigorous a private company can make. The business has to prepare massive amounts of information, which must be independently checked, to demonstrate that it is has a strong track record and a promising future. If there is any doubt about the long-term viability of the business, the investors (which are mostly large institutions) just won't buy.
3.The suggestion that Private Equity firms make unreasonable fees by subterfuge and double-dealing. The terms of investment in a fund and the associated fees are clearly set out by the firms during the fund raising round. The investors are all wealthy individuals and large institutions, and the final terms are the result of long negotiations. If the last fund was a success the PE firm is in a strong negotiating position, but if the last fund didn't match the competitors' success then they may have to trim the fees this time around. Ronaldinho earns a ridiculous amount of money for kicking a football, but as soon as he stops delivering on the pitch he will drift into the lower leagues and his earnings will shrink.
4.The suggestion that Chapter 11 is part of the PE investment strategy. Bankruptcies happen and in an asset class that has invested over US$ 100 bn in businesses last year, there are going to be high-profile failures. However in order to be a successful PE investor, you need banks, businesses and investors to see that you have a strong track record of leaving businesses in a better condition than you left them.

Overall the article is selective in its examples to support a particular view. It overlooks the overwhelming number of success stories. The majority of PE investments fall into two categories. Firstly spin-off businesses that have lacked attention in a large conglomerate. As TP notes in the Investec presentation spin-offs are generally more successful than IPOs and they are mostly financed by Private Equity. PE firms do not just bring finance but also expertise in making the transition to a stand-alone business, inserting a quality management team (which may have been lacking whilst lost in a large congolomerate), assisting in finding partners, new acquisitions and international expansion. The second category contains businesses with untapped value due to weak management who have lacked the courage or ability to take the right decisions. If this situation has gone on too long the business may be a turnaround case, with most conventional investors keeping well clear. This is where PE firms save jobs contrary to popular myth, by unlocking the hidden value and investing in the right areas to ensure the business can survive and thrive.

There are some valid points in the article lost in the fog. There is increasingly too much Private Equity money chasing limited quality assets and forcing up valuations. As the CEO of Blackstone, Stephen Schwarzman pointed out at the recent Superreturn conference “When even the dumb guys can raise finance, then we have a problem”. This is true of any market which has had a good run for a number of years, whether it is the housing market or the 1990s technology market. When people think you can make a great return just by being there then a clear-out is not far away. However, once this clear-out is over the best and brightest investors will still be making market beating returns by spotting undervalued businesses with weak management, or hidden in a sprawling conglomerates.

It is also true that all these transactions create large fees for bankers, lawyers, consultants and accountants. Not exactly award-winning journalism. Welcome to Wall Street. Every time you see a merger, IPO, new financing, restructuring or share buyback there will be significant fees going to a small number of wealthy advisors. Not all of the side-effects of the capitalist system are pleasant, but young, wealthy bankers seem to annoy the journalists most of all.

Posted by Elwood at March 12, 2006 7:37 AM

Elwood - a robust rebuttal. Among the many senior executives I talk to who are running companies owned by private equity funds, I've found a wide diversity of opinions about whether PE is a good thing or a bad thing. What seems to unite the "positive" execs is that healthy cash flow is helping pay down debt. Either the company was not overburdened with debt in the first place or the business was bought on the cheap and there's plenty of upside for management and the fund out of a sustainable business model.

But there are plenty of people who can tell you horror stories. Funds chasing a deal too hard (to get the money invested before they start to look bad), overpaying and having to screw the business for cash. PE managers allowing the fund's life-cycle dictate their approach to exits and even strategy. And, worst of all, PE firms creaming off huge fees creating a requirement for a "top-up" premium on returns from investee companies. Bad money chasing out good? I think that part of the private equity story has to be told.

Yes, there are good and bad PE firms and bankers. But almost all of them are taking too much money in return for the facilitation services they provide to businesses. Financial services is a closed shop - high fees and poor customer service wouldn't be allowed to survive in today's airline or grocerey industries. But the bankers continue to make super-profits without offering super-service. And on that score, the Forbes article hit the nail firmly on the head.

(And yes, young, wealthy bankers annoy this journalist, too.)

Posted by Richard at March 15, 2006 5:20 AM