Private Equity Firms Popularity Changes Business Landscape
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JEFFREY BROWN: On Wall Street, it’s all the rage: big deals, worth hundreds of billions of dollars in the past year alone, in which major publicly held companies are bought by so-called private equity firms. The latest and largest deal was announced yesterday, when the private equity giant Blackstone won a bidding war to buy Equity Office Properties, the nation’s biggest office landlord. The price tag: $39 billion.
The past year has seen other huge deals, including the buyouts of the hospital chain HCA for $32 billion, Harrah’s Entertainment for $27 billion, and Clear Channel Communications, also for $27 billion.
To help us understand what’s going on, we’re joined by Colin Blaydon, director of the Center for Private Equity and Entrepreneurship at Dartmouth’s Tuck School of Business, and New York Times business reporter Andrew Ross Sorkin. He edits the paper’s financial news blog, “DealBook.”
Andrew Sorkin, why don’t we start off with a definition? What exactly is a private equity firm?
ANDREW ROSS SORKIN, New York Times: Well, you know, a private equity firm actually is a polite term for what we used to call LBO firms, or leveraged buyout firms, in the 1980s.
You might recall the book “Barbarians at the Gate,” which chronicled KKR, Henry Kravis from Kohlberg, Kravis and Roberts buying RJR Nabisco, in what was then the largest takeover in history.
And so these are firms, basically, that pool capital, so they take money from pension funds, wealthy individuals. They put it in a pot, and then they leverage it, so then they take out effectively a mortgage on it. So they may take $100, and they may get a $900 mortgage from the bank, and then they go and buy a company.
They buy that company, they turn around, hopefully, for them, in a couple of years, fix it up. They may strip the company down. Sometimes they — a lot of people lose jobs. That’s one of the controversies. And then they sell the company. And that’s pretty much what private equity is today.
JEFFREY BROWN: Professor Blaydon, tell us a little bit more about where all that money comes from. And how is so much available to these firms?
COLIN BLAYDON, Center for Private Equity and Entrepreneurship: Well, it’s the size is really a recent phenomenon of really just the last two years. The money comes, as Andrew mentioned, particularly from pension funds.
So one of the interesting things is, is that it’s particularly the public employee pension funds, our school teachers, firemen, policemen, civil servants, who are the beneficiaries of the success of these private equity funds. Also, a big hunk of the money comes from university endowments and through foundations.
And the reason they’ve gotten so big is because, about two or three years ago, these funds began to have some phenomenal successes. They bought some companies right after the tech and telecom bust, when the economy was not performing very well. They bought them at good prices.
And the debt markets, the lenders out there in the world, began to make more and more debt available to these funds to do their deals with. So they were able to do a deal. They were then able to quickly restructure, maybe put more debt on the deal, give a quick early return to their investors, and people noticed that they were having this great success.
And the pension funds were desperately looking for places to make big investments where they could make substantial returns, because many of these pension funds are underfunded and worried about being able to meet the pension promises that have been made.
So they stuffed a lot more money in, and they got even bigger. So we have now seen the first $15 billion private equity funds and two funds that are currently in the market for $20 billion.
The details behind the deal
JEFFREY BROWN: So, Andrew, with that context, tell us a little bit, by way of example, about this latest deal, the one yesterday. Who is Blackstone? Why would they buy a big real estate office firm?
ANDREW ROSS SORKIN: Well, you know, this deal almost took on somewhat of epic proportions. People compared it to "Barbarians at the Gate." They called it "New York at the Gate," because of the personalities involved.
Steve Schwartzman founded Blackstone Group, which now is the largest private equity firm in the country. And he was pitted against a fellow named Steve Roth, who used to be the king of strip malls in New Jersey, at a firm called Vornado, which is a real estate investment trust.
And it pitted both of these guys against each other trying to buy equity office also run by a colorful character named Sam Zell. And so you have all three of them in this very interesting bidding war, bidding battle.
Perhaps the most interesting element of it all is Sam Zell is also an aspiring poet. And he would send poetry to Steve Roth, also one of his good friends, saying, "Roses are red, violets are blue, I hear a rumor, is it true?" And Steve Roth would write back, "Roses are red, violets are blue, I love you, Sam, my bid is $52."
JEFFREY BROWN: And, Andrew, is the expectation in this one, too, that Blackstone would eventually sell it off, sell off parts, or sell off the whole thing?
ANDREW ROSS SORKIN: Absolutely. In fact, what you've already seen, funnily enough, they spent $39 billion buying the business. By Friday, they plan on selling $7 billion worth of the assets as they try to diversify their risk.
That's one of the things I think you're seeing with all of these deals. They're buying the businesses, but they are immediately shedding and selling different pieces of the business.
Clubs have gone 'elephant hunting'
JEFFREY BROWN: Professor Blaydon, what about the risks here, potential downside of all this?
COLIN BLAYDON: Well, this party was brought to us in large measure by the generosity of the debt markets. Debt has never been so plentiful to put on to deals or available on such attractive terms.
JEFFREY BROWN: Well, what exactly does that mean, debt is so available?
COLIN BLAYDON: Well, it means that they can borrow more money against the deal they want to make. So they can put more debt into a deal and less equity than they were able to a few years ago. And, plus, the terms and conditions that they have to meet about repayment are much more generous than they were a couple of years ago.
And the third thing is, is these guys have learned to play well together. It used to be these buyout firms, back in the era that Andrew was talking about, were pretty passionate about having sole control of the companies they took over. They've learned to collaborate.
So they are now coming together, in what they're calling clubs, and groups of them are now bidding for these companies. So they've got more money that they've been able to raise, that the pension funds have largely given them, more debt to put on the deal. And they have learned to collaborate.
And these clubs have gone elephant hunting, because the big companies out there are the ones that are probably today among the most attractive targets for them to take over and take private.
Justice Department's regulations
JEFFREY BROWN: But, Andrew Sorkin, I also understand that these clubs, as just described, have also raised some questions from the Department of Justice about whether they're being fair to public shareholders.
ANDREW ROSS SORKIN: Absolutely. Absolutely. I think one of the big questions in all of these take-private situations, where you have public companies becoming private, there's a question as to, are shareholders getting a fair price for their shares?
And the Department of Justice is looking at whether these clubs or consortia that are coming together are actually working to artificially deflate the prices, to keep pricing down. And so they've begun a preliminary inquiry. We don't know how far it's going to go, but it clearly is an issue that is on everyone's mind.
You know, the number of transactions that are taking place with public companies going private and the number of managements participating in these take-privates -- so they're getting a big chunk of the equity in these companies. They're making a fortune. It has a lot of shareholders worried about which side they're really on.
The cyclical nature of the business
JEFFREY BROWN: Andrew, you started this talking about the days of "Barbarians at the Gate." So is it right to see cycles of business history here, where we go through these private buyouts, and then public company big mergers, and now we're back, you know, in the private buyout mode again? Will it turn ever so?
ANDREW ROSS SORKIN: There's no questions this is a cycle. This is a cycle that has grown, though, in a way that no other cycle has, because of the confluence, both of the enormous amount of money that's out there, but just as importantly, you have CEOs today and managements and boards today saying, "We don't want to be public anymore. We don't need to deal with shareholders."
The costs of dealing with the regulatory issues, the Sarbanes-Oxley, we can do a lot better in the private environment. So the cycle is -- we are definitely in a cycle. The question is where we are in that cycle. We're probably closer to the end than we are to the beginning.
But, you know, at some point, this merry-go-round probably does have to stop.
JEFFREY BROWN: Professor Blaydon, we only have about 30 seconds. Do see you the same cycle and the cycle turning once again?
COLIN BLAYDON: This is certainly a cyclical industry and the people who are the participants in it certainly anticipate the cycle to turn. It will probably come about because some kinds of crisis of confidence in the debt markets and/or a downturn in the economies around the world.
But for the moment, nobody's seen either of that, so it looks like people are going to party on for at least the immediate, foreseeable future.
JEFFREY BROWN: All right. Colin Blaydon and Andrew Sorkin, thank you both very much.
ANDREW ROSS SORKIN: Thank you.