“Returns from private equity won’t match those from the last 30 years.”
It took until the second-to-last sentence of Andy Kessler’s anti-PE ramble in the Wall St. Journal Monday morning for me to find anything with which I agreed, but, then, you know what they say about a broken clock.
Private equity has more cash than it has ever had before, its top managers apparently learning from major missteps of the last decade. Washington hasn’t moved any closer to killing off the industry’s golden goose either — so why is anyone predicting PE’s demise?
Among the mischaracterizations Kessler applies to the industry: private equity is out of “fat targets,” he guesses at how LBO firms are holding back GDP, and speculates that interest-rate tax deductions will finally get the axe in Washington.
Let’s take his points one by one.
To clarify: private equity isn’t not buying big companies because the Treasury Dept., in conjunction with the Federal Reserve, have imposed a 6-times Ebitda rule upon US banks that prohibit them from lending excessively. If BC Partners can spend nearly $US10 billion to acquire PetSmart, though, the era of the big deal is clearly far from over. Private equity firms that want to get around DC regulations only need to place debt with banks based overseas in order to get deals done.
“Capital will still chase increasingly expensive deals,” the column says, predicting, after: “That won’t end well.”
But the biggest buyers as of late have been corporate players, taking on massive transformative deals, often pushed by activists seeking better short-term returns.
Post-crisis, private equity quit the deals that got them in the most trouble
Private equity on the other hand, has eschewed buying outsized assets, because, historically, they have performed poorly as investments. Blackstone Group, which bought out hotel chain Hilton before the financial crisis hit, returned to public markets with the company in an IPO that has increased value since its 2013 debut. But it’s unlikely Steve Schwarzman will be reloading his elephant gun for any more mega-transactions; the fund through which Blackstone backed Hilton is comparatively an underperformer, held against its other funds.
So, it looks like, post-crisis, private equity might have learned a lesson. The Carlyle Group, of the biggest publicly-listed PE firms, has been most conservative with its dealmaking approach.
Yet, Carlyle, according to its own figures, invested more ($US9.8 billion last year vs. $US8.2 billion in 2013) and realised more ($US19.7 billion in 2014 vs. $US17.4 billion the year before).
Investors keep pouring money back into private equity firms
The ‘realised’ figure is the big one, and not just because it’s more than double what Carlyle spent. Private equity’s investors — often, big public pensions or other multi-billion dollar asset managers — say, almost universally, that the rate at which private equity has returned cash in recent years, often via big IPOs, is far greater than the amount of capital they have accepted for new deals.
One said, asking for anonymity because it might reflect some mismanagement on the investor’s part, his private equity funds returned so much money, so fast, that he is in a position of needing to spend more than he initially allocated for private equity. Translated: private equity has made its investors so much money after the financial crisis they are hard-up for ideas to put it to use. More than likely, it’s going right back where it came from.
In some cases, it already is: Warburg Pincus, as of a report this morning, was raising a $US12 billion fund, Blackstone is expected to raise a fund that could near $US20 billion in value and the aggregate amount of capital held by all the private equity firms exceeds $US1 trillion.
Kessler’s column also alleges that private equity has held back GDP growth by eliminating jobs at struggling companies — a familiar complaint of PE deetractors. One of the things they have yet to explain, however, is how the economy would have improved GDP without private equity involvement and companies, instead of being acquired, slid into bankruptcy. While an investor that buys a company and cuts 100 of 600 jobs has, in fact, reduced headcount, there is an alternate argument that they may have saved 500, too.
After that making that point, Kessler jumps into the legislative mosh-pit in Washington, saying that tax reform being pushed by Republican Senators Marco Rubio and Mike Lee eliminates the deductibility of new debt. All that’s wrong with that notion is that private equity executives have donated to both sides of the aisle on Capitol Hill for years, as well as the great unlikelihood of said legislation being signed in the White House, if it somehow garnered the approval of the rest of Congress.
Which brings us back to the second-to-last sentence of Monday’s WSJ column: “Returns from private equity won’t match those from the last 30 years.” This, in fact, is likely true. But it is only true because of the relative outperformance of the industry relative to other peer asset classes (like venture capital, or, the S&P 500), as well as the fact that private equity’s next 30 years will be characterised by a greater concentration of capital than in its earliest days, when LBO barons like Kravis could more easily wring a buck out of a poorly-managed target.
Kessler’s points go a long way to explain a number of things taking place in the private equity business, right now: it is, in fact, tough to put money to work (private equity firms have found more middle market deals, though) and, long-term, there could be legislative headwinds to face. But, right now, private equity is sitting pretty. And investors have bet $US1.2 trillion that’s going to stay this way, for a while.