Tuesday, January 30, 2007

Barbarians at the ( India ) Gate...?

If the bidding frenzy for Hutch Essar made interesting read, it was much more intriguing to read about Ranbaxy and Cipla being wooed by bigtime PE funds like KKR, Blackstone and other usual suspects for the generics business of Merck at a perceived valuation close to $ 5.1 billion – as a consortium. While the PE funds bring in the money in a mix of equity & leveraged debt, the Indian companies are expected to provide management expertise.

We’ve heard about the biggest buyout deals by PE funds in healthcare and real estate in the US, though. KKR and others bought hospital company HCA (NYSE: HCA - news) for $33 billion, breaking the $30.6 billion LBO record that KKR established in 1988 with its takeover of RJR Nabisco. The record was broken again when Blackstone and other investors bought Equity Office Properties Trust for $36 billion.

How long would it take for the PE attention to turn towards lowly geared Indian Public companies…? What will it portend for Indian retail investor…?

Imagine a Reliance Industries, Infosys, Wipro, Telco, Tisco going private…? Then to go into PE hibernation for about 3-5 years, dole out large dividends with leveraged debt before re-emerging with more vigour and higher valuation in the public markets again…? Not farfetched. Rather it’s a snap job given their relatively low market cap vis-à-vis that of the US corporate majors which have been gobbled up already.
It flashed across my mind as I read the news “Essar Group to exit from Indian bourses”. The cost of the acquisition of shares will be in excess of $ 435 million, a back-of-the-envelope calculation showed. This is small change for the Ruias ( majority holders of Essar ), who are expected to get around $ 1.3 billion if and when Hutch Essar, in which they own 33%, is sold to the highest bidder.

Going by the trend, I wonder is it not being signalled by the string of PE buyouts in Indian Companies big and small, the latest one being Blackstone investment of $ 275 million in Ushodaya Enterprises Ltd (UEL), a large media and film production company owned by Ramoji Rao,

P.V.Shahad’s VC Circle reports this is probably the largest deal in the Indian media and entertainment business. UEL is also raising bank financing of $190 million, which takes the total fund infusion to $465 million.

In the US, Managers of companies bought out by private equity funds are seen resorting to savage cuts to pay the interest on huge debts taken on to finance the deals and give pay-back to the private equity owners, meanwhile allegations of collusion to force down buyout prices are being made against private equity companies KKR and Blackstone.

2007 could be the year when private equity chickens may come home to roost. But should you buy when Private Equity sells ?

While Regulators on both sides of the Atlantic are investigating the sector, class action law-suits against private equity firms for collusion in the US are being initiated, and some deals are beginning to unravel messily. SEBI had better keep a close watch.

As the year closed, private equity firms took perhaps the ultimate step toward joining the business mainstream. On Dec. 26, 11 firms formed a Washington lobby group, The Private Equity Council. Private equity firms have begun to come under closer scrutiny, as the size of deals they pull off has soared and the amount of money they wield has grown. Success always comes with a price. In this case, it's attention.

Did you hear the doorbell...?
Wait - it could well be Barbarians at the (India ) Gate !

Friday, January 19, 2007

PE and LBO - where are they headed...?

Some excerpts from an insightful interview by Justin B Wender, president of Castle Harlan, a Private Equity firm in New York as appeared in New York Times. Covers a lot of contemporary questions on club deals in private equity, their sustenance and how fair it is to Public investors when PE funds take public companies private etc. It gives some wonderful insights

( may need a simple process of registration to read. Worth it. Just check out ).

Few snippets :

“ Q. Will the wave of private equity deals increase, or is it nearing the end of the cycle?

A. Given the dollars raised in private equity, it’s likely we’re going to continue to see significant-size leveraged buyouts. But it’s important to remember that this represents a relatively small percentage of all the securities traded in the United States. I don’t believe this is a huge cycle that’s cresting. It’s just a function of the money that’s been raised.

Q. Why are public companies going private to fix themselves, instead of restructuring while they are still publicly traded?

A. As to why some companies are going private, there is increasing scrutiny and regulation, namely the Sarbanes-Oxley Act, and that has had an impact. Chief executive officers are spending much more of their time on compliance issues and dealing with shareholders and analysts and the outside world. They have less time for their business than they might like. And when they’re private, they can dedicate time to the business itself.

Q. Are you suggesting that a climate has been created in which public companies can’t really take tough steps to correct their business model?

A. I don’t think that’s true. But there are challenges in making changes in public companies. There is constant scrutiny. The research analysts and others are constantly digging into the business and putting out research. You have a lot of public documentation that has to be filed. You can’t spend 100 percent of your time fixing the business.

Q. Who are some of the C.E.O.’s who’ve been lured into the private sector?

A. One good example is David Calhoun, leaving General Electric for an opportunity to join an LBO of the Dutch firm VNU. The public speculation was that he got a $100 million package to lure him. So here’s a guy who was a vice chairman at G.E., where he ran $60 billion in revenues, and he left.

Q. Isn’t it bad for the average investor that people are taking companies private and reaping big gains that public shareholders might otherwise have shared in?

A. The only way that a private equity firm is going to buy a business is as a result of a process in which the board looks for other buyers. Nobody is buying a business without paying a market-clearing price. Now, are private equity guys taking upside profit that shareholders would have gotten? The complication with that analysis is that doing a buyout creates a different risk profile. If you take a business and double its debt, you’re taking different kinds of risks than when public shareholders were involved. The other point to add is that most of these buyouts probably will end up being taken public as an exit vehicle for these private equity firms.

Q. Isn’t it bad for the average shareholder, at least in the short term?

A. Isn’t that an apples-to-oranges analysis? Return and risk are correlated. When these buyouts happen and more debt is put on the company, it’s a different level of risk. It’s not exactly comparable to say that the same amount of equity value would have been created. There may be situations where the public market doesn’t appreciate aspects of a business that a thoughtful private equity investor might see. “

Friday, January 12, 2007

More concerns on optimal deployment of mega PE funds

I have aired my concerns ( “No Way Out”) relating to the prospect of PE investors funds getting locked up for lack of exit opportunities. At that time, I was fresh from the report of Sevin Rosen Funds having retuned funds to investors citing lack of investible opportunities and laggard IPO markets.

I was also not pretty much sure about the potential for optimal deployment and returns generating capabilities of PE firms engaged in a bidding war in most emerging markets ( “Flipside of PE buyouts” ), where the acquisitive ego often side-stepped valuation math. I had flagged caveat emptor for the winning bidders in Hutch Essar.

I recently found support in a Red Herring article, where there’s an added interesting perspective on such record PE fundraising in 2006 ( 322 firms raising $215.4 billion ) and its impact across industries, Venture Capital and the relative risk and suspicion. Very insightful.

Wednesday, January 10, 2007

Flipside of PE buyouts

Private equity has been a turbocharger for the market. Every time private equity takes a company private, they pay a big premium and investors mark up the rest of group in the hope that another PE firm will come along. This has forced private equity to pay ever higher prices for the deals they do. As long as rates remain low and the economy is strong, private equity can pay up.

What if tables turn…?

Our capitalist system has a habit of swinging between fear and greed and right now we’re seeing it lean toward greed – at least in private equity. Wealth has accrued, and investors — many of them public pension plans — are searching for places to put their excess capital. So they’re parking it with the huge private equity firms and hedge funds promising to put large dollars to work profitably. As per reports, PE firms firms raised a whopping $198 billion in 2006 ( a record ) and almost five times the amount raised in 2004. They pumped $ 725 billion to take public companies private, and buying divisions from public companies that are trying to restructure. That’s another record, more than twice the level in 2004. The trend is expected to continue this year. One firm, Apollo Management, alone participated in $37 billion of transactions in just three days.

Looks like things are getting out of control. With PE firms buying up all these companies, they will need to sell or take those companies public again, in order to cash out of them. But no one knows how they will do that. If you try to sell these companies on the public market at the same time, the resulting downward pressure will kill the stock market. ( Firms will have to hold their stakes, thus lowering returns, and causing a shakeout). Meantime, the excess cash is pushing up stock values artificially, because if a company doesn’t like its stock price, it knows it can get a premium price by selling to a private equity investor. Alternatively, if a company’s stock price dips too low, it becomes an acquisition target. So, of course the market has gone up! The Dow is at record highs.

That’s the problem. Most economists would like 2007 to herald an economic slowdown. If it slows too much, we could be in for a choppy ride. It takes a long time to unload stock, even in the best of markets. I recall Roger McNamee helped buy disk drive maker Seagate in 2000 while he was at Silver Lake Partners. Though Seagate’s value rose within a year or two, and is now near an all-time high — creating handsome profits for Silver Lake on paper — the firm has been unable to sell Seagate shares very quickly. It still owns a large portion of Seagate shares — six years later. And that’s a near-ideal case.

For the past couple of years, private equity has been a safety net under the public market. Stocks go down less than you would expect on bad news because private equity is there….So many companies went private in such a short period of time, that you have to wonder what happens in three years when they all want to go public again. What happens if the market says no ?

Another example is the purchase of Warner Music Group for $1.25 billion in 2003, by a group of investors led by Thomas H. Lee Partners. Within two years, Warner Music made dividend and other payments to those investors of $1.43 billion, in other words paying off the Thomas Lee and other investors the entire cost of the acquisition. Like Seagate, the investment represents a fortuitous case. However, even in these best of conditions, Thomas Lee has been unable to knock it all home with a sale. It is stuck holding to the company, with a declining stock price. Warner can’t merge with EMI, as originally envisioned, because European anti-trust regulators have said no.

The bubble might continue to grow for a while, because there’s so much cash still looking for a place to go. But its time for investors — and here we mean state employees and others whose pension fund money is being pumped into these PE funds — to start asking questions. It’d be too bad if joe public investor is left holding the bag again, just like in 2000. I’d rather hope not.