Private Equity's Golden Age Wasn't So Golden After All

Henry Kravis

KKR & Co. Co-Founder Henry Kravis.

Photographer: David Paul Morris/Bloomberg
  • Buying spree heralded by KKR has yielded mediocre returns
  • Investors would have fared better with money in an index fund

Henry Kravis called it private equity’s golden age. From 2005 to 2007, buyout firms paid fat prices to buy about 20 supersized companies, from Hilton Worldwide Holdings Inc. to Hertz Global Holdings Inc.

Now, a decade later, the results of that debt-fueled spree can be tabulated -- and it’s hardly golden. The mega-deals produced mostly mediocre returns, falling well short of the profits that leveraged buyout shops typically seek, according to separate compilations by Bloomberg and asset manager Hamilton Lane Advisors. In more than half the deals -- each valued at more than $10 billion -- the firms would have been better off if they had put their investors’ money into a stock index fund.

Henry Kravis
Henry Kravis
Photographer: Daniel Acker/Bloomberg

Have the Masters of the Universe learned a lesson? They say they have. Caution is now a watchword and less is more. TPG Capital has sworn off buyouts as large as $30 billion, people with knowledge of its thinking said, while other shops will consider enormous deals only if the price is right. But so far none has led a $10 billion or bigger transaction since the financial crisis.

LBO Boom’s Final Score

“The big deals were done more out of ego than economic sense,” said David Fann, chief executive officer of TorreyCove Capital Partners, which advises pension plans that invest in buyout funds. “People paid steep prices and put on too much debt.”

Representatives for Kravis’s KKR & Co. and TPG declined to comment.

Buying Frenzy

Private equity firms make money by charging investors -- pensions and other institutions -- an annual management fee equal to 1.5 percent to 2 percent of the funds they raise. They also keep 20 percent of any profits when a company they acquired is later sold.

The firms typically want to, at least, double investors’ money within three to five years. But a decade ago, a buying frenzy stoked by low borrowing costs saw firms pay sometimes twice as much for companies as dictated by traditional sales and cash flow multiples. That behavior almost guaranteed so-so returns, buyout executives now say.

Private equity firms led 19 purchases worth more than $10 billion from 2005 to 2007, according to data compiled by Bloomberg. As of Dec. 31, the deals earned the firms a median profit of 40 percent above their investment cost -- well below their goals.

Smaller Deals

The results also pale when compared with the 70 percent median return yielded by all private equity transactions during that period, the Hamilton Lane study shows. That group includes thousands of smaller deals.

On an annualized basis, the largest deals generated a median 4 percent return, according to the Hamilton Lane study, which looked at 25 transactions from the era. The Standard and Poor’s 500 Index, by comparison, returned 7.3 percent a year from the start of 2006 through 2015.

“This crop of deals dragged down private equity returns,” said Joe Baratta, global head of private equity at Blackstone Group LP. “The entire industry has become more disciplined.”

The private equity shops justified the high prices at the time by saying big and established companies could weather a possible downturn. But the post-2008 meltdown dashed that conviction, imperiling companies big and small.

KKR was the most active player, leading or joining in nine of the deals valued at more than $10 billion. Its record was mixed. Four of those transactions notched solid returns of 2.2 to 5.1 times the firm’s money. KKR co-led the highest-returning jumbo-deal, that of hospital owner HCA Holdings Inc.

$8.3 Billion Bet

But KKR also participated in four deals posting modest returns of 1.1 to 1.6 times what investors put in. Then there was the record $48 billion buyout of TXU, now called Energy Future Holdings Corp., which was the only total equity wipeout of the 19 mega-deals. The company’s 2014 bankruptcy vaporized an $8.3 billion bet led by KKR, TPG and Goldman Sachs Group Inc.

TPG had a subpar record for its seven buyouts, totaling $160 billion. On top of its Energy Future debacle, TPG suffered a loss in its purchase of casino operator Harrah’s, now Caesars Entertainment Corp., and gained nothing in participating in buying Freescale Semiconductor Ltd. In four other deals, it eked out a profit of half or less what it invested.

Most Profitable

Blackstone and Carlyle Group LP, the two biggest buyout firms, and Bain Capital distinguished themselves among the group by doing multiple deals and dodging any losses. Blackstone led the $26 billion purchase of Hilton, a deal that has morphed into the most profitable leveraged buyout ever in dollar terms -- a $10.8 billion partly realized gain as of Dec. 31, for an annualized return of about 15 percent.

With notable exceptions -- Energy Future, Caesars and Intelsat SA -- the deals clawed their way back to profitability thanks to a resurgent stock market, debt restructurings and streamlining. But that wasn’t enough to produce buoyant returns. One reason is that big public companies tend to trade at higher multiples than smaller firms.

“The fundamental flaw with large public-to-private deals is you pay the full market rate,” said Scott Sperling, co-president of Thomas H. Lee Partners, which ponied up an above-average 16 times cash flow for Univision Communications Inc. “That decreases the odds you can sell the company later for a higher multiple.” He declined to discuss the performance of his firm’s deals.

PE Playbook

Another problem, said Blackstone’s Baratta, was that many of the big companies were well run, leaving less room for operational improvement -- a key element of the private equity playbook.

“You’ve got to know going in that you can drive up growth and margins,” as Blackstone did with Hilton, said Baratta. With Biomet Inc., by contrast, “there was less we could do to transform the business.”

The companies also were too big to sell for cash. That left a public offering or a sale, paid for in stock, to a publicly traded buyer as the only paths to an exit. But unloading shares takes time, eroding annualized returns.

A mega-deal revival is also being deterred by curbs the Federal Reserve has set on loans tied to buyouts, executives said.

While buyout titans are exercising caution, whether they remember the lessons is an open question, said Josh Lerner, a Harvard Business School professor who researches the private equity industry.

“Memories often last a decade” after a crash, Lerner said. “Getting them to last two decades may be over-optimistic.”

AnnouncedTargetIndustryDeal Value ($bn)BuyersTotal invested equity ($bn)StatusReturn multiple
2007TXUPower48KKR, TPG, Goldman Sachs8.3Exited0x
2006Equity Office PropertiesCommercial real estate38.7Blackstone3.9Active2.7x
2006HCAHospitals33KKR, Bain, Merrill Lynch4.9Active5.1x
2006Harrah’sGambling, lodging30.7Apollo, TPG6.6Active0.3x
2007First DataPayment processing29.8KKR10Active1.1x
2007AlltelTelecom27.5TPG, Goldman Sachs4.6Exited1.3x
2007HiltonLodging26Blackstone6.4Active2.7x
2006Clear ChannelBroadcasting, advertising24Bain, Thomas H. Lee2.9Active1.1x
2006Kinder MorganOil & gas22.4Goldman Sachs, AIG, Carlyle, Riverstone7.9Exited2.8x
2007Alliance BootsDrugstores22.2KKR4.9Active3.5x
2006FreescaleSemiconductors17.6Blackstone, Carlyle, Permira, TPG7.1Active1.0x
2007IntelsatSatellite services16.6BC Partners, Silver Lake1.5Active0.2x
2005HertzCar rental15.3CD&R, Carlyle, Merrill Lynch2.5Exited2.6x
2005TDCTelecom15.3Blackstone, KKR, Permira, Providence, Apax2.7Exited2.2x
2006UnivisionBroadcasting13.7Madison Dearborn, Providence, TPG, Thomas H. Lee, Saban5.2Active1.3x
2006BiometMedical devices11.6Blackstone, Goldman Sachs, KKR, TPG5.4Active1.5x
2006NielsenTelevision ratings11.3KKR, Thomas H. Lee, Blackstone, Carlyle, Hellman & Friedman, AlpInvest4.2Exited2.7x
2005SunGardSoftware, IT11.1Silver Lake, KKR, Bain, Blackstone, TPG, Goldman Sachs, Providence3.6Active1.4x
2006NXPSemiconductors10.5KKR, Bain, Apax, Silver Lake, AlpInvest5.5Exited1.6x
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