Inside Investment: Endgame for private equity
Buying into the IPO of a private equity company is like a game of pass the parcel in which someone has already made off with the prize. Those that choose to play will end up disappointed.
The news that Kohlberg Kravis Roberts is to acquire Alliance Boots, which would be the first takeover of a FTSE100 company by a private equity firm, confirms that the barbarians are not merely at the gate but have trampled it down and are partying in the grounds. No company is safe. Mega-deals such as the Boots bid and TXU Corp acquisition, at $45 billion the biggest-ever private equity transaction, are becoming commonplace. The biggest ever public-to-private deals are also under way in Australia and Canada, for Coles Group and BCE Inc, respectively.
The sheer chutzpah of these deals seemingly speaks volumes about the overweening confidence of the private equity industry. However, they might also be a classic manifestation of the observation that an organism is most active before its death. Of late, when they haven’t been hogging the headlines for their hyperactive deal-making, private equity firms have been appearing in the financial pages because of their own plans to list.
On March 22 Blackstone announced that it would seek to list up to 10% of the firm on the New York Stock Exchange for as much as $4 billion. Two weeks earlier Blackstone’s chief executive, Stephen Schwarzman, had opined at a public meeting: "I think public markets are overrated." Since then Apollo Management, headed by Leon Black, has been reported to be interested in pursuing a similar course to Blackstone.
The inherent irony of this development is obvious from Schwarzman’s quote. This is an industry built on the idea that public markets are not the best medium for companies to raise capital. So why the volte-face? The huge success of the listing of Fortress Investment Group in February clearly has other private equity groups salivating at the prospect of attaining a similar valuation.
Fortress sold 8.6% of the company for $685 million at an IPO price at the top of its expected range of $18.50. On the first day of trading the shares soared almost 70% to $31. They now trade at $33, valuing the company at more than 40 times historical earnings. By comparison, London’s Man Group, the world’s biggest listed hedge fund company and arguably the most awesome distribution machine in the entire alternatives investment arena, trades at 18 times.
That is crazy. But both Blackstone and Apollo are far better known than Fortress, so unless markets suddenly slump it does not seem unreasonable that they could achieve similar valuations. Even so, the motivation of the sellers is intriguing. These firms have raised record-breaking amounts of capital in recent years. The headlong dash into alternatives by pension funds and other institutional investors shows no signs of abating. Put simply, they do not need capital.
However, shareholder equity is permanent capital, and funds, even when the investors are locked in, are not. When Carl Icahn, no stranger to self-enrichment, says of Leon Black: "I think he is out to make a lot of money", no one should be in doubt what the prime motivation of the principals of these firms is. The benign credit conditions and abundant liquidity that have fuelled the private equity boom also offer a once in a lifetime opportunity for these masters of the universe to cash in their principal asset.
Buyers of this equity should beware. Bob Dylan said: "You don’t need a weatherman to know which way the wind blows". Well, you don’t need to be an über bear to think the perfect climate enjoyed by private equity will not persist for ever. The average multiple for a private equity deal is now nudging six times ebitda, a record. Those multiples can only make sense if there is abundant, cheap credit on the way into a deal and a booming, confident stock market on the way out. If either the credit or the stock markets turn, those at the private equity party will be nursing a hangover.
Don’t take my word for it. Here are some thoughts from William Conway, chief of the Carlyle Group, from a leaked internal memo: "...most investors in most asset classes are not being paid for the risks being taken"; "...the longer it lasts the worst it will be when it ends"; and: "If the excess liquidity ended tomorrow, I would want as much flexibility as possible."
Flexibility is precisely what permanent capital gives to those running private equity firms. Wall Street’s masters of the universe have exhibited one primary skill, making money for themselves. The notion that they will leave some on the table for public shareholders is more than just quaint – it is patently absurd.
Andrew Capon is editor-in-chief at State Street Global Markets, the research and trading business of State Street Corp. He was formerly senior editor at Institutional Investor and has won numerous awards for journalism on fund management and investment issues. The views expressed are the author’s own