Posts Tagged ‘PE’

What if PEs stop trying to turnaround failing companies?

January 17, 2012

The fanned hysteria against private equity firms is ripe with hypocrisy and unintended consequences.

The hypocrisy is almost comedic.

Gingrich was on the board of Forstman-Little.

Obama just promoted Jack Lew – formerly head of Citi’s PE group – to be his chief of staff.  And, don’t forget that Team Obama picked Dan Akerson to run Government Motors. What’s his background?

Prior to joining GM, Akerson was a managing director and head of global buyout for The Carlyle Group in Washington, D.C. In this position, Akerson managed more than $50 billion in assets and more than 200 portfolio companies with several hundred thousand employees around the world. He was instrumental in helping Carlyle achieve 30 percent gross internal rates of returns in the firm’s corporate private equity business.

Gee, sounds a bit like Romney doesn’t it?  I’d even be willing to bet that Akerson closed a few plants and laid off a few people in his time.

That’s not bad.  That’s how failing businesses are turned around.

Which leads me to my bigger point.

Connecting some dots, I see a disturbing trend.

  • A doctor friend of mine opined that if MDs start getting paid based on “success rates” then docs will simply start taking fewer difficult cases … why risk your pay check on on high risk patients? … treat the ones that are certainly curable … bingo, high success rate
  • Similar story with a dedicated teacher friend … asked about pay based on students success (e.g. test score improvement) … he parried: fine, then who’s going to teach the mainstreamed special needs students … or the incorrigible discipline students …  not the teachers striving for high success rates.

Easy to project those stories into the PE debate,

PEs go into turnaround situations knowing that tough actions will need to be taken, that companies will need to be restructured, and that some managers won’t make the cut.  That’s the way businesses are turned around

And, they know that – despite their best efforts – some turnarounds will fail.  That’s part of the game.

If the world lasers in on the unsuccessful attempts, who is going to step-in and start taking on the toughest turnarounds?

If the answer is nobody – or worse yet, the Feds – then those failing companies are certain for demise.

Is that what Gingrich and Obama want?

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Re: PE firms … some academic findings.

January 13, 2012

Punch line: Private Equity has found itself under the media spotlight the past couple of days, thanks to Newt’s shots at Romney.

At the risk of burdening the hysteria with facts, here are the results of some academic studies reported by Business Week

PEs most common strategy is simple: buy an undervalued company, usually with borrowed money to juice returns. Whip it into shape. And after five years or so, sell it back to the public, paying off the debt and keeping the profits.

Private equity firms genuinely unlock value through “strong incentives to management, strong oversight, and operational consulting.” They force bad managers and deadwood employees to look elsewhere for work.

The PEs also benefit from special tax breaks, including the “carried interest” rule that allows them to treat their profits as lightly taxed capital gains.

More specifically …

  • According to Preqin, a London-based data provider, 25 percent of the dollars going to private equity funds from 2009 to 2011 came from public pension funds. That included teachers in Texas, California, and New Jersey. A second big chunk of investment comes from college endowment funds
  • Studies show that private equity firms are excellent at generating returns for their investors … An analysis of 598 buyout funds that existed between 1984 and 2008 found that even after fees, their weighted-average returns to outside investors were 1.27 times the returns on the Standard & Poor’s 500-stock index over the same periods …
  • A Harvard Business School working paper looked at the employment patterns of 3,200 firms targeted by private equity from 1980 to 2005 … the study concludes that in comparison to the control group, the PE firms’ employment shrank “less than 1 percent” in the two years after a deal.

Ken’s Take: The emerging backlash against private equity will likely have some  unintended consequences.

Question: What if the PEs stop investing in failing companies because they get skewed if they either do the necessary restructuring (i.e. shutter plants and jettison deadwood employees) or fail to turn the failing firms around.

Answer: The failing firms fail and all jobs are lost … or the Feds step in and make taxpayers subsidize inefficient, non-economic businesses.

I’d rather have PEs take the risk with private capital …

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