Corporate takeover, leveraged buyout, alternative asset management, private equity — whichever the popular term-of-the-day happens to be (presently the latter), the current push for private equity (PE) firms to list in the securities market has caused many public investors to turn heads and take notice.
Once famously known for being secluded and enigmatic, the PE industry finds itself now at the front doors of potential shareholders with a welcome cake in its hands and a Cheshire cat-sized smile upon its face. This may very well be innocent enough, but as newly transformed publicly traded companies, it begs the question: Will these private equity companies change their model to suit the needs of their shareholders or will they continue to do what is best for the limited partners, as they have traditionally done? Or is it possible to appease both types of investors considering their polarizing investment objectives?
In the not-so-distant past (say two years ago), there was a time when your typical leveraged buyout company, or LBO, would not have to put on a spectacular song-and-dance show in order to get lenders clamoring for more performance with promises of high returns. Pension funds, financial institutions, insurance companies, and universities, just to name a few, were all too eager to give and had more than enough capital to finance the market’s funds. But as recovery from domestic macroeconomic factors as well as the global impact of a weakening euro sovereign credit, coupled with the industry entering a new unchartered business cycle, pressure began to mount. So much so that in recent years some of the largest LBO companies in the world like Blackstone (NYSE: BX), Kohlberg Kravis Roberts & Co. (NYSE: KKR), Carlyle (NASDAQ: CG) and Oaktree Capital (NYSE: OAK) have all changed their tune about opening their own doors to the public.
For the managers of PE funds, general partners, pressure was also exacerbated in finding “quality” investments needed to absorb the $949 billion in dry powder accumulated — committed capital from limited partners — before expiration or risk sacrificing management fees. According to Bain & Co., a private equity research company, more than 4,500 companies accounted for the nearly $1 trillion in dry powder — more than $400 million of it from buyouts alone. All this of course is happening at the same time when exists that would have normally been pushed back until the upcoming year were being conducted before the pending 2012 tax break on the PEs carried interest ran out.
The following data provided by the Private Equity Growth Capital Council revealed that:
- U.S. private equity activity declined in the first quarter of 2012, primarily due to investment volume, which fell by 70% from $42 billion the previous quarter to $13 billion, while…
- fundraising declined by 17% from its previous quarter to $20 billion and exit volume falling 22% from its previous quarter to $24 billion.
- On the other hand, the average equity contribution by sponsors of U.S. leveraged buyouts increased to 44% in Q1 2012 up from the previous quarter of 38% and with callable capital reserves (dry powder) for global buyout funds increased to $382 billion in Q1 2012.
Consequently, as is the story for most companies struggling for acceptance from public investors after entering the IPO market, the same has been plagued for PE firms as well. Since going public in 2007, the market has not been kind to Blackstone. After the company took in $4.1 billion, at the time the largest IPO since the dot.com bubble, BX’s stock has dropped 60.55%, closing out last week at $13.94.
Not to be left out of the competition, in 2012 Oaktree and Carlyle were the two latest top-rated private equity companies to go public. And the two newly-traded firms have made for some pretty interesting reads, to say the least. As Oaktree’s stock has declined by 14% since its initial trading day on April 12 and as its earnings for the first time as a public company reported a 30% decline, CEO Howard Marks made his own headlines when he purchased the largest New York City’s real-estate deal on record for a Manhattan apartment for $52 million.
While Carlyle’s shares have increased 18% after having closed below the offering price nearly every day since came after much cause for concern with investors when the company attempted to adopt a “provision in its charter that would prevent public investors from suing in court over corporate misconduct and securities fraud,” according to the New York Times. Only KKR & Co. shares have fared well; up 50% overall since its IPO induction in 2010.
Sluggish stock performance, poor market valuation, and low earnings expectations are some of the claims that private equity clients have given as reasons that PE firms could fall privy to market pressure and lose focus on deal-making. “A private equity firm might be tempted to sell a holding to help bolster profits during a tough quarter, for example, instead of holding on and selling for a greater return down the line,” as reported in the WSJ.
While from a public investor standpoint, critics against PE companies joining the stock market say these firms will not provide the average investor with enough sources of earnings and that investors will not be able to have any “real” stake in the company; as Carlyle, for example, released only 10% worth in shares during its IPO, and that general partners (GP’s) will use the proceeds from the sales of its shares just to cash out. Further criticism is aided with several of these companies using the IPOs last year as a means to pay off the $14 billion in debt acquired in the buyouts and in return loading top executives pockets’ with billions to burn, according to Bloomberg reports.
What’s in it for the public investor? Why choose a public PE firm at all?
Let me first say that PE companies in and of themselves are not evil do-wellers but the role of the leverage buyout company is to do exactly that, buy other companies. Whether it’s to reorganize existing ones, find that hidden gem in start-ups, to be a sponsor for other companies, or help “create” jobs (as some would argue), PE companies makes funding investments –and themselves- possible. The challenges that the PE industry will soon face, low portfolio valuations and even lower fund returns due to accounting and pricing methods, will only heighten GP’s to concentrate on overall fund performance. Public investors would be wise to do a double-take on buying into the private equity market.