Private Equity: a Primer
Public offerings by big private-equity firms like KKR and the Blackstone Group have generated lots of headlines lately. But this rareified form of finance remains opaque to many investors. The following FAQs help explain what private equity is, why it matters, and how ordinary investors can participate.
What exactly is private equity?
The term refers to a class of investments that are privately owned rather than publicly traded in the stock market. Private-equity firms such as the Blackstone Group, the Carlyle Group, Kohlberg Kravis Roberts & Co. (KKR), and TPG launch funds through which they raise capital and borrow money to buy troubled or under-performing publicly traded companies. These days, private-equity funds are targeting companies of all sizes, including huge industrial concerns. For instance, earlier this year, Cerberus made history when it announced a plan to acquire a majority stake in the automaker Chrysler.
Is private equity a new development on Wall Street?
Not exactly. KKR, which recently acquired Dollar General, put private equity on the map in the late 1980s with its famed hostile takeover of RJR Nabisco. You might recall that this leveraged buy-out was the focus of the bestselling book Barbarians at the Gate. Today, some of the nation's leading businesses are owned by private-equity firms. Among them: Metro-Goldwyn-Mayer, Toys "R" Us, Dunkin' Donuts, and Neiman Marcus. Moreover, one of the leading Republican candidates for president, former Massachusetts Gov. Mitt Romney, has strong roots to the private-equity community–he made his personal fortune running the private-equity firm Bain Capital.
What is new, though, is the sheer size of the current wave of buyouts. So far this year, private-equity deals have accounted for nearly half of all merger and acquisition activity, based on dollar values, according to Thomson Financial. That's up from less than a third in 2006. And this is at a time when M&A activity is hitting record levels.
"Public-to-private deals continue to fuel the market," explains Greg Peterson, a partner in PricewaterhouseCoopers's transaction services group. Going forward, he predicts, the level of activity will depend on the amount of cash available to finance deals and the availability of takeover targets that offer investors sizable returns. Sectors ripe for more deals, according to PricewaterhouseCoopers: financial services, telecommunications, media, and software.
Is this a good trend for the markets?
It's hard to say. That judgment may have to be made on a case-by-case basis. For instance, some would argue that there's a real value-minded approach to these private-equity deals. After all, these private investors are looking at troubled or stagnant businesses that are often neglected or punished by short-term-minded stock investors. But at the same time, the goal of private-equity investors isn't to hold the business for a lifetime. As soon as they've invested enough capital in a struggling business to turn it around, they're looking to sell it. So it's not as if these firms are buying businesses with the same mind-set as, say, Warren Buffett.
What's been driving the boom in private equity?
Part of it is good old-fashioned greed. In recent years, some of the most successful private-equity firms have generated returns for their investors about three times as high as those the stock market has delivered. And many investors want in on the action. This may explain why institutional investors–including pension funds and charitable foundations–have become much more willing in recent years to invest outside of the traditional stock market in an effort to boost their potential returns.
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