The belly of private equity
Private equity is a bit of a mystery, as reported in the business press. The companies themselves are rather secretive, reflecting their private ownership. They also move in ways that are not very well documented in the business press. Yet in terms of industry consolidation and the growth of oligopolies, the subjects of this blog, they are becoming increasingly important. Whereas strategic buys once far outnumbered equities buys and almost all of the biggest deals were strategic, now it seems that equity bidders are in one almost every buyout and are winning an increasing percentage of them.
The new trend was recently highlighted by the $33 billion purchase of the #1 US hospital chain, HCA, by a consortium led by equity groups Merrill Lynch Global Private Equity; Bain Capital; and Kohlberg, Kravis, Roberts, the largest private equity deal ever. Almost at the same time, Blackstone Group announced it had put together a $15.6 billion private equity fund, the world's largest, and was looking for what to buy.
The stand course of events, as I see it, is as follows. Usually the purchase is made with a leveraged buy-out (LBO), so not all the investors' money is tied up. The equity fund management gets a 1% to 2% management fee per year for supervising the investment. The fund management usually hires new corporate management with experience in the field, and give the turnaround executive team support to restructuring the company, which may consist of selling off units, cutting jobs, rebuilding and refocusing. The execs are given a several year timetable, something never afforded to execs in a public company, who have to answer to stockholders each quarter. This way, the private management can make moves that have a three-or-four year time frame.
Ideally, at the end of from three to seven years, the equity fund is in a position to sell off the restructures company to one or more strategic purchasers at a premium, often 100% or more. We've written about the buffer effect. In a typical set-up, the equity fund managers get 20% of the profit when the deal is made. Equity funds generally have a number of investments, so if some don't pan out, there's also the possibility of a few going for 200% of the purchase price or more.
Alternatively, an initial public offering (IPO) is made, and the company re-emerges as a public one, sold on the stock market and the equity fund and the investors pocket the money from the IPO. It's not impossible that the new company will soon be bought out by a strategic buyer or taken private again after a short period. Sometimes the IPO is the lure that brings in a strategic bid from a company that makes a last minute deal to bypass it.
In many cases, the sale is to another equity firm or consortium of equity firms. This kind of private-to-private deal is getting more common, and can happen at any time after the initial buyout. Presumably, the buyer thinks it can do a better job with the property. Or it may be that the LBPO funding is due, and some other equity firm has arranged funding. IN many cases, the price tag on this private-to-private transaction is kept secret.
The equity funds within a Carlyle, a Blackstone, a Gain, are usually independent entities with their own separate P&Ls. Those companies themselves are loosely organized, with the individual fund managers given a lot of power and responsibility.
Right now, an unprecedented situation is happening. Because so much capital has entered into the equity funds in the last few years, there is an extraordinary number of dollars invested in companies that are not yet ready to be sold, many of whom are in the first few years of equity ownership. The practice of selling from one equity group to another is also exacerbating this situation.
We might think of it as a growing part of the economy in the belly of the equity beast, only partially digested. (You can take the metaphor further if you wish.) The question is whether there will be real, strategic buyers or investors eager to buy all these properties when they are ready for sale and when the investors and fund managers are eager to take their profits.
Any clarifications or corrections from my readers would be appreciated.
8:58:47 PM 
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