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Mon Nov 14, 2005 1:00 am Post subject:
NYT: The Great Global Buyout Bubble |
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New York Times
November 13, 2005
Dealbook
The Great Global Buyout Bubble
By ANDREW ROSS SORKIN
A YEAR ago this week, Henry R. Kravis, the legendary buyout mogul who
invented the modern-day private equity industry, gave a rare speech to
a group of investors in a ballroom of the Waldorf-Astoria. In
describing how far the business had come, Mr. Kravis, a slight man with
a dry wit, recounted how difficult it had been for him to raise $355
million to buy one of his first companies, Houdaille Industries, in
1979.
"The availability of financing was our biggest challenge," he said.
"Literally, we had to add up the potential capital sources at that
time, which consisted of several banks and insurance companies, and one
by one go out and raise the money."
Today, he has the opposite problem. Investors have been throwing money
at the red-hot leveraged-buyout industry - so much so that Mr. Kravis
now has to turn away some of them, rejecting their cash as a mere
"commodity."
Private equity firms, it seems, now own everything: Hertz, Neiman
Marcus, Metro-Goldwyn-Mayer, Toys "R" Us and Warner Music, to name a
few. So far this year, buyout firms have spent more than $130 billion
gobbling up parts of corporate America. And with more than another $100
billion in unspent money this year still swirling around the industry,
there is a lot more buying to be done. The boom isn't limited to
America: in Britain buyout firms own so many companies that they now
employ 18 percent of the private sector, according to the British
Venture Capital Association.
The trillion-dollar question is whether these shopaholics are setting
themselves up for a giant fall. If the market begins to show even the
faintest signs of strain, this bubble may pop, say many financial
analysts as well as private equity players themselves. If that happens,
the leveraged-buyout boom and bust that Michael Milken led in the
1980's could end up looking like a dress rehearsal for the mess to
come. As Mr. Kravis said during his speech: "Unfortunately, there is a
flip side to having access to plentiful capital. It means that too many
people without experience in building businesses have too much money."
The numbers tell the story. Over the last three years, private equity
firms have had record returns through a series of quick flips, spurred
in part by superlow interest rates that allowed them to borrow huge
sums of money. As a result, big institutional investors like pension
funds have poured $491 billion into the business, according to Thomson
Venture Economics, a firm that tracks data for the industry. If you
figure that the firms can borrow three to five times that amount - a
conservative assumption - the industry has more than $2 trillion in
purchasing power.
But here's the rub: In the next three years, to reap returns on all
those big-name investments they have been making, private equity firms
are going to have to sell $500 billion worth of assets. The question
is, to whom? Even in the last three years, in as big a bull market as
they come, private equity has never sold more than $153.2 billion in a
year, according to Freeman & Company. At the same time, the investment
firms will have to keep spending. And the low-hanging fruit has already
been taken.
"There's no question this is going to end badly for some," said Colin
C. Blaydon, a professor at the Tuck School of Management at Dartmouth
and the dean emeritus of its Center for Private Equity and
Entrepreneurship. "It's almost a classic boom-bust cycle. When you see
a big boom, people see the returns, go rushing in, stuff more money in
than can be dealt with. Suddenly, something will happen that makes
people say: 'Oh, my God! Look at the leverage we've got on these
things. Isn't this way too risky? Shouldn't we pull back?' And then the
question becomes: Does it crash like a rock or is there an adjustment
down over time?"
ALREADY, there are reminders that the business can turn ugly overnight.
Thomas H. Lee Partners, the Boston private equity firm famed for buying
Snapple for $135 million in 1992 and selling it two years later to
Quaker Oats for $1.7 billion, recently was badly burned on its
investment in Refco, the commodities trader that filed for bankruptcy
protection last month. While the setback has hardly sunk the Lee firm,
it is an illustration of how risky these investments can be.
Firms may have a particularly tough time exiting some of their
investments because investors are taking a more skeptical view of
initial public offerings backed by private equity. In recent months,
several high-profile quick flips have left critics wondering whether
buyout firms were using such offerings simply to line their pockets,
rather than using the proceeds to support companies.
Earlier this year, the Blackstone Group sold a German chemicals
company, the Celanese Corporation, to the public after owning it for
less than 12 months. The firm quadrupled its money and all of the
proceeds from the offering were used to pay out a special dividend to
Blackstone. Mr. Kravis's firm, Kohlberg Kravis Roberts & Company, also
quadrupled its money by flipping PanAmSat, the satellite company it
owned for less than a year.
Investor scrutiny of private equity-backed I.P.O.'s forced Warner
Music, which is owned by a consortium of buyout firms led by Thomas H.
Lee Partners, to scale back its offering significantly: the firms made
several last-minute adjustments that kept them from cashing out as much
as they had hoped, in part as a way to inspire confidence in the
offering.
According to Dealogic, which tracks the industry, initial public
offerings backed by private equity firms have performed worse than
other offerings; the average first-day return for a
private-equity-backed I.P.O. this year is 8.3 percent, compared with
13.9 percent for other offerings. Analysts ascribe some of that
discrepancy to concern by investors that private equity firms will
later cash out of their position, depressing the stock price. Over
time, though, that gap often narrows and some private equity offerings
have outperformed other offerings.
Then there is the issue of sky-high prices that some private equity
firms have been willing to pay for acquisitions. According to Standard
& Poor's, buyout firms now pay, on average, about eight times a
company's earnings before interest, taxes, depreciation and
amortization - or Ebitda, a common measure of cash flow - for companies
worth more than $1 billion. That is a significant increase from a
multiple of about 6.5 only several years ago. Private equity firms have
felt comfortable paying more because debt remains so cheap and banks
have been willing to allow the firms to add ever-larger amounts of
leverage to transactions.
But if the debt market turns against them - and it is bound to do so at
some point - potential buyers or public investors may not be willing to
pay the same prices. In the consumer retail sector, where private
equity firms have paid prices of more than 12 times Ebitda during
frenzied auctions, selling may be especially tough. Tommy Hilfiger and
Dunkin' Brands are both for sale, and some bidders have already left
the auction, a sign that the price may be moving too high.
"I'm pessimistic about the economy, interest rates, credit markets, and
all that," said Hamilton E. James, president of the Blackstone Group.
"I feel people are paying prices that are too full. I think some
mistakes will be made. We've pulled in our horns a little. We've become
more conservative about the types of companies we buy, the prices we
pay, the exit multiple assumptions and so on and so forth."
Of course, many people in the industry disagree with the premise that
there is a bubble ready to pop. They note that private equity is still
only a small part of the mergers-and-acquisitions and I.P.O. market,
and they say that if they've done their homework, they will have made
the right bet.
Even Mr. James, the economic bear, is still bullish on the overall
leveraged-buyout market. "I have no concern about the markets being big
enough to accommodate L.B.O. sponsors getting liquidity for their
successful, good-quality portfolio companies," he said. "The very
growth of private equity, don't forget, adds a whole other option: the
secondary buyout," referring to a trend in which private equity firms
buy and sell businesses to one another.
YOU can't argue with that. But not everyone can make a brilliant bet,
and headwinds can make things more difficult.
The advent of supersized deals also lurks below the surface. For years,
buyout firms focused on businesses worth several billions of dollars at
most. Today, flush with cash and under pressure to spend it, private
equity firms are splurging on huge businesses like Hertz ($15 billion)
or SunGard ($11.3 billion). The Computer Sciences Corporation is being
eyed for a $12 billion takeover. But selling those businesses or
putting them back in the public markets could be even more difficult
because of their size.
How will this shake out? Will the bubble pop? For some, absolutely.
There will be bankruptcies, restructurings and fire sales. Others, who
made the right bets, may be luckier and be able to ride out the bad
years.
"In hot markets, you can sell crummy companies," Mr. James said. "In
less ebullient markets, the really marginal companies take more than
their disproportionate share of the pain. That's where you'll see it."
http://www.nytimes.com/2005/11/13/business/yourmoney/13buyout.htm
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