The Joy of Private Equity
Private equity's proponents see privatizing as a fine way to fix a troubled business. Detractors say hooey—going private is about the money and that such deals do little more than make a few people very, very rich. The question: Do buyout firms like Blackstone Group (BX) and Kohlberg Kravis Roberts add value to companies or just collect a heaping wad of cash?
Kenneth Langone, the billionaire investor and Home Depot (HD) co-founder, is clearly in the quick-buck camp. As an old-time wheeler-dealer, he views private equity as little more than a way to "get more juice out of a lemon" for investors—and Langone has no problem with that. "It ain't complicated," he said on Aug. 6 at the Academy of Management's annual conference in Philadelphia, explaining why private equity deals get done. "We tend to mystify simple math."
The recent boom in private equity has been widely credited with helping to propel stocks to new highs this year as easy access to credit expanded the range of companies that buyout firms could target. That, in turn, spurred investors to bet on which public enterprises would be taken over at a fat premium. Huge companies such as Chrysler (DCX), Alltel (AT), First Data (FDC), Harrah's Entertainment (HET), TXU (TXU), and Clear Channel Communications (CCU) have all been targets of multibillion-dollar private equity deals in the past year. Now, however, mortgage fears have led to a credit contraction, which could upend the attractive financing terms private equity firms have exploited to bankroll their deals. A shortage of easy money could cause some leveraged buyouts to unravel, leaving investment banks holding billions of dollars in debt that they're unable to sell.
Langone, who had waited impatiently for his turn to speak, went right for the economists present. Strategy, management, agency cost, alpha and beta—Langone would have none of it. "It's kind of like sex," he said, citing some of his early deals, from Home Depot to Schaeffer Beer. "There's nothing new about it."
Harvard economist Michael Jensen, an expert in private equity investment, stressed the nuances and importance of what private equity aims to accomplish. Jensen's name may be unfamiliar to the public, but he pioneered the study of private equity firms and predicted their ascendance in an influential 1989 article, "The Eclipse of the Public Corporation."
"It's not just arithmetic," Jensen said, contradicting Langone. "It's a new model of corporate governance." Jensen argued that the private equity model holds a key competitive advantage: perspective. Public companies must disclose quarterly results, which focuses managers on the short term. But private owners look to the longer term, yet not too long, since each private equity fund has an expiration date. Furthermore, private equity funds typically run businesses more efficiently, using a fraction of the people at headquarters than at public companies. Moreover, if a private equity partnership underperforms, that's it—they're done, Jensen said. But shareholders of a public company can be stuck for years with inefficient management and poor performance.
What accounts for the differences? Andrew Metrick, an associate professor at the Wharton School, who spoke before Langone and Jensen, views the disagreement as a difference in perspective. Jensen has been studying private equity firms from the inside for years. "Langone is a guy who can hit the curveball, and to a guy who can hit the curveball, it's easy," Metrick said.
Ultimately though, both shared more common ground than they admitted. Jensen expressed major concerns over the latest rounds of leveraged buyouts, which has seen firms getting away from the governance model that made them so effective in the past. And Langone conceded that taking a company private can be a way to solve intractable problems.
"I'm all for the private equity guy," said Langone. "People who invest in them, no one's putting a gun to their head. They're doing it to make a quick buck."