Thursday, March 01, 2007

Taking on the Myths of Private Equity

Private equity is getting plenty of attention these days. Headlines routinely mention firms such as Blackstone Group, Kohlberg Kravis Roberts, Texas Pacific Group, Carlyle Group and Providence Equity Partners as they recount the latest record-breaking buyout or takeover of a well-known company.
But Providence Equity chief executive Jonathan Nelson suggests that private equity’s new prominence has a downside: The rise of some widely accepted myths about the buyout business that could end up hurting the industry. “While many appreciate our role,” he told an audience of private equity professionals earlier this week at the Super Return conference in Frankfurt, “more still do not understand what we do and how we do it. Name recognition is not the same as real understanding.”
So Mr. Nelson ticked off what he considered to be five myths about the private equity business and tried to dispel them. Below, the myths and some excerpts from what he had to say about them:
* Private equity is private
At one time, private equity really was private, but our business has changed over the years as capital markets and our strategies have evolved. There are now many windows into our world. Consider the following realities that you all know:
First, many private equity investments soon return to the public arena in the form of an IPO — and the PE firm often continues to own a large stake in a public company. Second, in many private equity investments, public bonds are issued as part of the acquisition financing, and this debt comes with disclosure requirements. […] State pension funds and other LPs are increasingly disclosing positions and returns of the PE firms they invest with.
* Private equity firms are star-driven boutiques
The days when a star founder or group of founders did it all — raise money, find new investments, court sellers, conduct due diligence, negotiate contracts, close deals, and sit on all portfolio boards …. those days are long gone.
My point is that people outside the business, and in the media, tend to focus on the prominent personalities in PE. But with all due deference to some of my colleagues who, in fact, are stars — I think the brand names that will ultimately matter are the emerging institutional brands – such as Blackstone, KKR, TPG, Carlyle and Providence to name a few.
* Private equity firms are institutions
Whichever side you come down on in the “Star versus Institution” debate, the fact is we have not yet seen or lived through an era when the founders retire and PE firms endure.
There are still very few examples of PE firms successfully transitioning from the founder to the next generation of leadership. While we’re all getting a little older, this is largely a function of the relative youth of the private equity industry itself.
* Private equity is easy
[T]he model in our industry today is far different than the headlines would lead you to believe — and it’s far more sophisticated than it was 10 or even five years ago. In today’s environment, you have to improve businesses, not just arbitrage public and private capital structures. Or said another way, you must work on the income statement as well as the balance sheet.
* The private equity bubble is about to burst
There is an important difference between high cyclical valuations and tulip mania. We have the former and are not yet approaching the latter […]
Since 2000, the term “bubble” has been overused by pundits, and it’s easy to latch on to that word today when we know we’re approaching a high point in the cycle. What’s misapplied here is the implication that we are headed for a free fall. I don’t expect that, but I also don’t expect the laws of gravity to be repealed. We will correct, multiples will contract and credit will tighten.
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