Sunday, May 20, 2007

Private Equity - History repeating itself?

There have been several interesting articles recently about the rabid pace of buy-outs by private equity firms. We have all seen the newspapers that discuss the issues of private equity engulfing ever more firms and in ever larger deals.

Is this good for the economy? It is certainly good for the stock market at the moment with buyout targets stock prices fueling ever more growth and therefore ever more speculation creating a vicious circle of rapid stock market appreciation. Seen that before? The dot com boom had similarities but for my money was a different kettle of fish. The Internet boom was a frenzy of optimism about the new media and how it could be utilised, money poured into some crazy ides at at alarming pace and the stock market lapped it up. Traditional valuation theory went out of the window and with it any hope of there being a happy end, and we all know, there wasn't.

So is the private equity boom the same? Yes and no. Wherever there is vast amounts of money chasing the same deals there is bound to be mistakes. Investment bankers/private equity house (are they any different these days?) are no strangers to being goaded into paying over the odds because of fear of losing fees, bravado or even, dare I say, greed. If you don't believe me see paragraph 2... yup, there would not have been dot com floatation's of a bazillion times earnings if some investment banker somewhere hadn't said it was OK, and some of these crazy ideas would not have got to market if some VC had not funded them.

Money is cheap at the moment and, it appears, in endless supply to hedge funds and private equity houses. This, to me, sounds like simple supply and demand. If there are more buyers in the market with more money chasing similar deals prices will rise and somewhere on that price rise scale there should be a big red mark saying "TOO EXPENSIVE". However, I suggest that this will be ignored and there will be a few spectacular failures in our not too distant future.

This time, fortunately, we are not talking about flimsy new age companies with a business plan dreamed up by some teenagers and plumped up by fee hungry investment bankers, today the product being pumped up by avaricious investors are companies with a history, Chrysler, ABN Amro to name but two. No, today we are seeing proper grown up businesses being bought and taken private with a view to offering them back to the markets in a few years where will be expected to believe that they have been cleaned up and are now worth twice as much as they were before.

Invariably, some of these old boys of business will benefit and will come back to us with a hip replacement and a dose of vitamins, skipping sprightly along to the second phase of their stock market life with new vigor and direction. Some, however, will come back with bloated management full of money and power. It is then that I believe history will repeat itself and will will see the de-merger cycle occur.

Come on, don't tell me you have forgotten already? Sir James Goldsmith, Carl Icahn etc. The corporate raiders who stalked businesses that had grown into huge conglomerates with diversified companies nothing to do with the core. Telecoms companies owning logging companies, biscuit companies owning tobacco companies was all the rage. These acquisitions and management were fueled by the knowledge that a smaller company couldn't borrow enough money to buy a bigger company. Management became entrenched and corporate excess became renowned. This all changed when 'junk bonds' put capital in the hands of the raiders who burned the fat while making themselves billions.

Still can't remember? Here is a reminder...

I can't help thinking that the private equity industry is lining us up for just such another feeding frenzy down the line, only this time undoing what the private equity firms are creating; monsters of business.

As a final thought, how come in the eighties the raiders told us that business was big and fat, and divesting non core businesses leaving a sleek core was the best and now we are being told (by some of the same people) that to survive in a global environment you need to be big, therefore mergers are the way to go?

I don't know, maybe I am being cynical, but if history has taught us one thing it is that when too much power is concentrated in the hands of the few, it is often at the expense of the many.


Anonymous said...


Interesting blog on investing you've got here. I picked up new stuff for myself. As I was researching Hedge Fund History, i hvae found this site to be full of Hedge Fund History and facts.

Check it out, I think you will like it

Asset Manager said...

Thanks..useful stuff from that site...thanks

Asset Manager