The New Face of Capitalism
Private buyers are gobbling up some of the premier names in corporate America
The earlier buyout wave revealed the potential downside of piling debt on companies-the turning of beloved brands like Federated Department Stores into bankrupt shells that had to struggle mightily to come back, giving private-equity firms a black eye for the immense sums they took out of such deals.
These days, private-equity firms have largely changed their stripes, taking on less debt and often concentrating more on building up companies rather than cutting them to the bone. But problems do remain. And private-equity firms are painfully aware of the damage bad publicity can do to their positive new image. Fear of being lumped in with hedge funds-whose own practices have drawn sharp attention from regulators-is one reason that Carlyle, Blackstone, KKR, and Texas Pacific Group are moving to form the Private Equity Council, the industry's first concerted attempt to educate the public and lobby the government. Colin Blaydon, director of the Center for Private Equity and Entrepreneurship at Dartmouth's Tuck School of Business, says the firms are setting up the council "largely because of the potential backlash they could get around the world because of their expanded activities."
The private-equity buyouts are fueled by several factors. The shares of many public companies, after wringing out the excesses of the late 1990s, are now trading at cheap prices compared with their underlying assets and revenue streams. The Sarbanes-Oxley Act, passed in 2002 as the antidote to a wave of corporate accounting scandals, makes it more difficult and expensive for smaller firms to go public and for already public firms to stay listed. And private-equity firms have found plentiful and cheap debt to leverage their own considerable treasuries, money hoards that continue to attract almost unprecedented amounts of capital from pension funds, university endowments, and wealthy investors seeking greater returns than found in the global stock markets. "When you are looking for historically high rates of return, where else do you go?" asks Dennis Block, a partner with the law firm Cadwalader, Wickersham & Taft who helped shepherd KKR's bid for RJR Nabisco. In recent years, even union pension funds-whose members can be on the other end of the stick when private interests take over and downsize some of these companies-have invested.
Although returns vary greatly, the best and the brightest private-equity firms often provide returns to their investors of 25 percent a year, experts say. Data from Thomson Financial and the National Venture Capital Association, an industry group, show that U.S. leveraged-buyout funds have averaged at least 13 percent annual returns over the past 20 years, and the California Public Employees' Retirement System recently reported cumulative returns of up to 133 percent over the past six years from one of its private-equity-fund investments.
"There has been an explosion in not just the number of funds but also the dollar value of the capital that they are raising," says Jeanne Montague of Montague Partners, a small San Francisco-based investment bank. "I can remember when the first announcement of a $1 billion fund set the market stirring. Now Blackstone has raised $15 billion in one fund. The numbers are becoming almost difficult to comprehend."
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