Spawn of Sarb-Ox
Private Equity goes on a Shopping spree
By blackhedd Posted in Economy — Comments (7) / Email this page » / Leave a comment »
The business world is going through a consolidation cycle, as assorted failures and weak sisters from the last several years get acquired by people who think they're buying low (and in some cases actually are). Today's multi-billion dollar deal is for telecom equipment manufacturer Avaya.
This happens every so often, but there is something different this time. In a word, private equity. What's really going on?
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By the middle of last year, I started getting confirmations that an interesting recalibration was happening in the world where business meets finance, where companies are bought and sold. It seemed like every deal category had moved up by roughly a zero.
Where you used to see venture capitalists making investments of a few million or tens of millions, now they're looking to invest hundreds of millions. And in consequence they've moved up to a different class of deals. No longer doing nearly as much classical venture, they're doing PIPEs, mezzanines, and coming in as partners on even bigger deals.
The very largest deals are still being done by public companies acquiring other public companies. And in this space, the deals are also getting a lot larger. Witness RBS's $95+ billion offer for ABN AMRO.)
But a space has opened up in the middle of the scale. Five or ten years ago, you'd have expected a company like Avaya to be taken out by someone like Alcatel or another public player in their industry.
Instead, Avaya will go private. Its buyer is a syndicate led by Silver Lake, a serious and very interesting firm with their thumbs in a lot of pies; and TPG Partners, the erstwhile Texas-Pacific Group. Yeah, they're the same guys that recently partnered with Goldman Sachs to take telecom services provider Alltel private. (What was that, two weeks ago???)
The Avaya deal is going off at $8.2 billion. I'm going to refrain from the traditional comments on the valuation given to Avaya's public holders, because I think the underlying dynamic is more interesting.
Private equity players, around the world, are stepping into the deal space just above the venture guys, that has been vacated by large public companies moving a step up the chain. Acquisitions with dollar valuations in 10 figures and low 11 figures now seem to be done largely with private equity. And anecdotally, the amount of money available globally for deals of this type seems to be at least a trillion dollars, perhaps a bit more.
What's happening?
Well, for one thing, as I mentioned, a cyclical consolidation is taking place. These happen every few years. A few years down the road, you'll see the opposite side of the cycle, with a lot of spinoffs and initial public offerings.
For another thing, everyone has a lot more money to invest these days, and there are only so many talented investment professionals to go around, so obviously they're going to seek bigger deals. (Think of it as the Warren Buffett effect: the better he does, the fewer companies he can buy without stretching himself too thin.)
But to me, public equity seems to be considerably underpriced, in quite a few sectors (manufacturing, finance, services, others). And this may not be cyclical. We may be seeing something new: public equity will systemically underperform for the foreseeable future. That explains why so many of the strongest hands in the business are buying up public companies like they were going out of style: they just might be going out of style.
What explains the undervaluations (if they are real)? That's a subject for another long post, but I'll mention two possible reasons here.
First, public companies are being managed too conservatively. It's true that today's shareholders are mostly very large institutions, but their goal is predominantly to achieve consistent returns rather than large returns. (Makes sense, if you're a pension fund, your job is to make sure Aunt Mary gets her monthly check, come what may.)
CEOs do what their bosses (the shareholders) pay them to do. And for public companies, that means: "give me a consistent quarterly return that's in line with other companies in your sector." As I've said elsewhere, stocks are the new bonds.
Second: Sarbanes-Oxley. There is a lot to be gained by being private in a regulatory environment where the managers and directors of a company are liable for jail time if they can't tell their auditors who has ever accessed any information bearing on the company's finances. And this dovetails perfectly with the availability of large amounts of private capital for LBO's in the 10-or-so billion dollar range.
So who gets the shaft? You might say individual investors do. I hate to say it that way, of course, because the financial industry is simply giving Grandpa and Grandma what they want, a comfortable stream of retirement income. But if the trend continues, it will no longer be possible for public investors to get the traditionally high returns we've been taught to expect from the stock market.
So should you buy the upcoming Blackstone Group IPO? Well, that's a subject for another post. But remember one important thing: the private equity guys are some of the sharpest tools in the box. They buy low and sell high. And if they're selling their own equity, well... I'll let you connect the dots.
Happy trading today, everyone.
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Spawn of Sarb-Ox 7 Comments (0 topical, 7 editorial, 0 hidden) Post a comment »
constitute another pain in the *$$, which on top of SOX, provides extra incentive to go private.
It will be interesting to see how the private companies perform.
From not-so-strange bedfellows:
Hedge funds and private equity groups need more regulation, the Party of European Socialists and Social Democrats and U.S. congressman Barney Frank said Monday.
The new types of financing are raising concerns in Europe, with some German politicians denouncing them for massive restructuring at companies they buy. Nevertheless, the European Commission, backed by the U.K. and other governments, has resisted calls for additional regulation.
Former Danish Prime Minister Poul Nyrup Rasmussen, the head of the socialists in the European Parliament, told a conference that hedge funds were immoral and dangerous because they caused economic volatility and disregarded workers' rights.
Congressman Frank, who is chair of the House Financial Services Committee, called by video link for a break with the "divide and deregulate" mentality, by which nations deregulate hedge funds and private equity funds to stay competitive.
"No compromise with the main purpose, no peace till victory, no pact with unrepentant wrong." - Winston Churchill
ACAS (American Capital Strategies)
American Capital Strategies, Ltd. is a principal investment firm specializing in management and employee buyouts, recapitalization, special situations, middle market, and growth capital investments. The firm seeks to provide mezzanine and debt financings for buyouts and also makes direct investments in public and private companies. In special situations, it invests in troubled situations and in distressed situations.
They do deals on a smaller scale than other LBO firms, with everyone going bigger as you point out, there is a niche on the small side (20MM to 500MM deals). It sports a 8 p/e and 7.5% dividend yield. Disclaimer: I own shares in ACAS.
The unintended consequences of Sarbox are the IPOs going to London and the private equity boom. And funny that Blackstone takes companies private but is going public itself.
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The CIA has better politicians than it has spies - Fred Thompson
Mezzanine isn't quite in the same space as the private equity players, but rather more comparable to the credit hedge funds. In any case, Sarbox isn't the main driver of IPOs going to London, it's the cost. G-d bless our investment banks and their cartel, they still charge about 7% fees on an IPO, whereas in London it's about 3%. Add in our lawsuit-happy culture and you have a volatile mix. China Life (LFC) was the biggest IPO in the world in 2003 (took place on NYSE) and within four months, it was subject to a class action lawsuit. Don't you think that would scare companies more than Sarbox?
And yes London's IPO market benefits from Sarbox, fees, regulation and lawsuits, the government can't really do anything about the fees, but they can repeal some of the worse parts of Sarbox, enact some reforms for law and regulation.
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The CIA has better politicians than it has spies - Fred Thompson
Three other factors contribute to the deal frenzy these days. Sarbox and Section 404 are easy to blame, but they really aren't as big a cause as you might think. Instead, consider the following:
1) The credit bubble. Credit is cheaper and more available than at any time before, which means that the private equity groups are able to lever up their acquisitions far more aggressively than ever seen before (back when I was a banker, 4.5x EBITDA was the limit, but as you've pointed out, we're seeing anything from 8x to as high as 10x these days.. insane).
2) Private equity shops are willing to execute deals with IRRs of approximately 20%, whereas even three years ago, the hurdle was 25-30%. They are thus taking on more risk for less return than in the past, which is leading to more aggressive deals.
3) Competition. Now we have strategics competing with private equity competing with hedge funds competing with VCs competing with angel investors. That's necessarily going to drive up the price, and with the rapidly diminishing supply present in the market (don't forget about stock repurchases!), things are getting a little frothy.
of SARBOX.. unfortunately government will most likely try to fix the problem with more meddling.
The regulatory costs of SARBOX are huge, especially for small public companies. Add in the predatory 'shareholder' lawsuits that wait in the wings reading between the lines of every 10Q/K and the result is to either go private or launch your IPO in another market (London is gaining popularity). I saw this first hand when I helped sell my old employer ($20M company) to a public corp. Then three years later, helped consult as they took it private again.
The public loses in the end, since they, for the most part, cannot participate in private equity deals and markets.
I don't see this Congress making any progress in this area since they are pro big-government.
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"Enlightened statesmen will not always be at the helm." -- James Madison