Private Equity: a Primer
But another contributor to the private-equity craze has been the supply of money available. Since the Federal Reserve eased monetary policy in the wake of 9/11, there's been a huge amount of liquidity that's been sloshing around the world's financial markets. And some of this cheap money was bound to find its way into private-equity funds.
Moreover, despite the stock market's recent gains, many investors believe that domestic companies are still trading at attractive prices relative to their earnings growth, and growth potential. The values that these private-equity funds see in the publicly traded stock market represent buying opportunities.
And finally, there's the interest-rate environment. By historic standards, market interest rates are still low, and this has made the cost of borrowing money cheap for private-equity firms. Remember, even though private-equity firms raise funds from large investors to buy out business, they still rely on a good deal of debt to help finance these deals. Of course, in recent weeks, market rates around the world have started to creep up, and some worry that this might remove a big tail wind propelling the private-equity market boom.
Is there a bubble forming in the private-equity market, like the technology stock craze of the late 1990s?
It's important to remember that private equity is not an asset like a tech stock, but rather a vehicle through which investors can purchase assets. So it's hard to imagine that a bubble is forming in this market. "Whenever people talk about a private-equity bubble, I cringe," says Tobias Levkovich, chief U.S. equity strategist for Citigroup Investment Research. He notes that while private-equity deals account for a high percentage of M&A activity based on dollar values, "at most, private equity accounts for only 25 percent of all deals." That means so-called strategic buyers–i.e., publicly traded companies buying other publicly traded companies–still account for the vast majority of M&A deals based on volumes.
What's the allure of taking a company private?
The thinking behind this strategy is simple. By taking a publicly traded company private, you remove it from the spotlight of the stock market. And some companies with major problems to fix or challenges to address–for instance, those with the need to come up with new products, strategies, or management–may perform better without Wall Street's persistent demands for high profits, quarter in and quarter out. Of course, once a company is fixed, its private-equity owners will quickly try to sell it or take it public again. In this sense, it's sort of like flipping a house. After investing money in necessary fixes, private-equity firms will attempt to resell the asset at a much higher price than they originally paid for it. Whether the company is sold or taken public again, the limited partners who invest in the fund benefit from the proceeds of the sale.
So if there's a benefit to private ownership, why are so many private-equity firms deciding to go public themselves?
That is the $64,000 question. Some of this may simply be a desire to make a fast buck while the private-equity trend is still hot. Remember, whenever a private business is taken public, the owners of that company can cash out with tens of millions of dollars. But there's more to it than that.
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