It's become quite clear to me recently that the general public has a perception of private equity that goes beyond any negative connotations associated with banking. People have a general understanding that private equity partners have the ability to create the kind of wealth (for themselves, it seems) that borders on the obscene at the expense of, well, them. To them, it's a simple equation: PE shop buys company (or "steals" it from the public markets), cuts jobs, creates self-wealth. As is usually the case, public perception is not always based on reality, and it's definitely not decided upon researching all the facts.
Not to mention that guys like Schwartzmann don't really help the cause.
Obviously, I am biased but am opening this up for discussion. Private equity can directly and indirectly create wealth for the public in several ways.
1) Any time a fund pays a significant premium to the market for a take-private transaction, shareholders benefit (and if they didn't, there's always a shareholder vote).
2) Limited partners of private equity funds include some of the biggest pension and retirement funds in the U.S. Private equity funds have consistently outperformed their public benchmarks, creating wealth for these LP's and directly creating wealth for the
"working class."
3) Any time a fund pays fees to investment banks associated with transactions, it increases earnings, public shareholders benefit. Seeing as how PE accounted for anywhere from 25-30% of M&A in the boom years, this is no small amount hitting the bottom lines of several large publicly traded financial institutions.
4) The rabid M&A activity that occurred through mid-2007 created an environment of highly speculative trading in which stocks that were deemed to be prime LBO targets had premiums built into their prices - more wealth to the public.
5) Financial sponsors, armed with more capital with limited time horizons in which to deploy it, actively sought bigger and bigger transactions, eventually creating intense competition with strategic buyers. For shareholders of the sellers, this only meant high multiples and bigger payouts.
6) PE owned companies were some of the best performing companies (top and bottom line growth) in the U.S. Creating a streamlined, efficient market may mean pain up front in the form of lost jobs, but can only make us more competitive in the global marketplace.
In regards to job loss in the hands of Private Equity the most recent study here:
http://www.thedeal.com/servlet/ContentServer?cid=… (subscription may be required)
or alternatively:
http://dealbook.blogs.nytimes.com/2008/01/25/stud…
Counter-arguments to my point: when PE funds, adding no operation value, used pure financial engineering to take advantage of an advantageous debt environment to overleverage and cripple healthy companies, while using multiple dividend recaps to recoup original equity and clear IRR hurdles. I would argue that this was rarely the case, however.
Thoughts?
For decades private equity didn't need to concern itself with the public relations efforts that so many firms of similar size have traditionally done in other industries. However, as the size, frequency and notoriety of deals increased, and the relative number of people it impacted grew commensurately, private equity came under scrutiny. As most lay people are ignorant, they filled the void with their own misconceptions. Today, many firms have public relations efforts. The Carlyle Group, through David Rubinstein, seems to be on a campaign for the last few years (he's been at just about every conference I have seen relating to private equity or finance). His slip-up at the Wharton Private Equity Conference aside (he told a protestor to take a remedial English class, he later had to call them and apologize; the irony is that he knows better: when someone is being petty and derogatory, you have to take the higher road, they will look stupid eventually), he has done a good job of being a spokesperson for the industry. Also, in addition to fighting on the tax issue, the Private Equity Council is a lobbying group that is putting out reports to defend the industry (statistics on creation of jobs, etc.).
I think the industry would be wise to concede on a few topics, like the taxation on carried interest. I suppose I can advocate that now that I am no longer a partner in the industry. I'll concede that I would feel differently if it were going to impact my personal cashflows. However, it looks like the change is inevitable. Congress is too focused on the issue. Why not embrace it and get a PR boost as a result? Keep politicians and the public out of potentially more thorny areas like regulation and disclosure. The costs there could put a lot of funds out of business.
Good discussion topic.
Check out Andrew Ross Sorkin's article in the New York Times through the following link:
http://dealbook.blogs.nytimes.com/category/private-equity/
-- Aseem Giri, Author of "Imposters at the Gate"
At some point, I subscribe to the "buyer beware" and it's corollary, "seller beware". If the capital markets dictate a company's worth at a certain value and a PE firm offers a premium on that price, no matter how obscene the profits, the PE firm is fully entitled to any benefits that accrue.
Now you can get into details and specific arguments (parts are worth more than the whole, financial engineering, etc. etc.) but the bottom line is with two responsible parties and no fraud or anything like that, you have to live with the results and a third party has no business crying foul.
The employee stakeholder issue is tricky because that issue subtly shifts it into more of a moral argument. By and large I am against stripping a company bare. True, at-will employment, etc. etc. but for most of working America the assumption is that if you do your job, you can expect a paycheck. Remember, financial services has a distorted sense of job security and that influences the thought processes of finance professionals. At this point though, reorgs are almost an inevitable part of PE and as long as there is a business case it would seem defensible.
I wouldn't bother with trying to narrow down where exactly private equity adds value to society. Leave it to Adam Smith and the theory of "enrich yourself legally and society will somehow benefit" as the basis for PE's value-add.
Sure, there are some that use purely financial engineering and the debt environment to acquire a company, make it lean, and flip it a few years later. It would be difficult to argue that they really add much "value to society." And this actually describes some of the biggest ones.
Other firms will focus more on consolidation plays - e.g., combining fierce competitors in a market, or investing in acquisitions to grow the business, looking at companies with similar customers that can be cross-sold to, etc. It's easier to make a case for these ultimately adding value.
Still other firms will focus on growth equity and actually providing funding to grow a real business, without much financial engineering and little to no use of debt.
And finally, VCs, at the complete opposite end of the spectrum, fund lots of companies that fail but could also fund the next Google. And clearly creating a great company adds value.
While the job cutting issue has certainly drawn a lot of attention to PE, I think the larger issue here is that financial services, by definition, do not really "add value" because we don't create anything. We buy and sell existing assets, and while sometimes we can add value doing so, it's the companies themselves that ultimately create value.
That said, I am in this market and will continue to be for some time. So I'm by no means denouncing what we do. I just find this whole PE bad press argument silly because you could make similar arguments about any type of financial services firm.
http://www.privateequitycouncil.org/
The Private Equity Council is the PE industry's government and public relations group. Although being obviously one-sided their website highlights many of the success stories in the Private Equity community.
Dosk, you bring up some interesting thoughts about financial engineering. Two deals stick out in my mind, Hertz and Celanese (Hertz was bought and taken public within a year, while Celanese was taken private in Germany and re-IPO'ed in the U.S. 9 months later). Strangely enough, I came across this article entitled "Not All Takeovers Take Away Jobs" outlining the details of the Celanese deal.
http://www.businessweek.com/magazine/content/05_27/b3941068_mz054.htm
If you'll recall, there was much hubbub in Germany following the Celanese deal and the subsequent re-IPO. Leonard Green is currently involved in a lawsuit with Werner regarding their dividend recaps now that Werner is filing for bankruptcy.
But with all this negative press, you really don't have to go far to see some of the positives. Many PE shops, including those involved in the Hertz and Celanese deals, employ senior advisors and operating partners - former CEOs and CFOs of large publicly traded companies, to help with operation improvements. For most, if not all, PE shops, mass layoffs are a last resort. And you'd be surprised that while you do see the occassional quick flip, many portfolio companies stay in funds for anywhere from 7-10 years. And not because they were terrible investments (investments gone sideways are usually written off to zero as quickly as possible), but because of a myriad of reasons (market conditions, previous sale process failed to yield attractive offers given performance, etc.). I know at my current fund just this past year we exited from an investment we held for almost 9 years and made almost 5x initial investment. I would argue that through our operating partners, we are able to add value in the companies we own. Sometimes adding value means taking seats on the board and demanding accountability. One of our operating partners, a former CEO with an incredible track record, is someone our CEOs look to speak to directly about strategy. Even our biggest and best run portfolio companies are learning from him every board meeting (I've seen this first hand, he constantly pushes our best management team to question why they can't be doing better - on top of already spectacular performance). I'd like to think that for the most part, the companies we own are better off when we sold them than we bought them, and exponentially better run than if we had never owned them at all.
GameTheory -- you make some valid points. Explain to me, however, how does Steve Schwarzman hurt the cause of increasing the image of PE? He is under so much media fire because, well, he has been very successful and very rich. Apparently this is something that makes you a bad person.
I am just sort of tired of this - any time there is a rant against PE it seems Swarzman is the scapegoat. I am not his personal PR rep, but I am not real sure what the guy did that sparked so much media negativity. He can eat $400 crabs if he wills because he made the money to do so and why is it that he needs to be criticized for his high standard of living?
It's like that video they made against PE on YouTube...it's not fair for Kravis to make so much money because they are people who earn minimum wage. Tell what sense does that make.
I have no problems with the food he eats or how much money he makes. I definitely don't have a problem with how he made his money. What I'm referring to is the over-the-top, ostentatious, multi-million dollar birthday parties inviting all of New York's socialites (half of whom he doesn't even know) to get himself all over Page Six.
Your point well taken - it's his money, he can do whatever he wants with it. But with PE treading water and Schwarzman as a representative of the industry (whether he likes it or not), well, I wouldn't say he has a responsibility to maintain industry image, but close to it. Case in point - the founders of the firm I work for probably don't have the wealth of Schwarzman, but are each individually worth well over 10 figures. As an associate with the firm I'm able to see firsthand how the other side COULD live. And not to say there aren't excesses involved - you almost feel guilty when portfolio company CEOs rib you about all the time spent on the company jets. Regardless of their wealth, the guys I work for are very low key. Despite the things they own, they shun the press and would never admit in print to how much money they make.
They don't sympathize with guys like Schwarzman, and the bad PR he brings upon himself. And they're not the only ones in the industry who disapprove. Here's Warren Hellman (from Hellman & Friedman) re: Schwarzman.
http://money.cnn.com/2007/10/15/markets/hellman_private_equity.fortune/…
You make a good point - he has made some lavish excesses as his birthday parties and so forth. But once again, he is rich and that's his lifestyle choice. Does Donald Trump's lifestyle put a stain on the real estate business? Schwarzman in my opinion has more of celebrity status now and he is like the go-to guy for media coverage on the PE industry.
His lifestyle doesn't help the PE industry's image for one simple reason: all the people who dislike PE do so because of the amount of money it has created for those who work in it. And, well, Steve has made more than most and that's what the problem is.
As far as Warren Hellman, well, I am sorry to say that, but it sounds like a whole lot of bitterness in his comments about Blackstone. That's the way I see it, at least. He says he could have raised more money for his fund but the bottom line is: his firm ain't Blackstone or KKR and chances are it never will be.
Anyway, I don't meant o hijack your topic so get back on track with the public war against PE.
Well, real estate and PE are two different animals. PE is a smaller industry comprised of primarily wealthy individuals, whereas real estate has many wealthy moguls, but also many individual investors and small investors. So, does Donald Trump give guys like Sam Zell a bad name? Possibly. When you think of "real estate mogul" more people think of Trump than Zell. That's neither here nor there, though.
People's perceptions of PE are based off of what they see in the media, and they carry those perceptions as stereotypes for the entire industry. I have no doubt that if Schwarzman threw his parties without inviting the press that less people would have a problem with the PE industry. I'm not saying don't do the things that enormous wealth entitles you to do, I'm just saying don't shove it in people's faces and give them a reason to hate you for it.
Hellman's arguement is that guys like Schwarzman, who thrive in the limelight, have brought so much negativity towards the PE industry that people now pay more attention to exactly how much wealth is created, and the tax on carry issue is a direct result. So the actions of few affect the bottom line of many.
Pepin...while I entirely agree with your sentiment, unfortuntaely that does not mean it is reality. We do not live in a perfect capitalistic system. Thus by drawing attention to himself and his firm he has created uncertainity for the future of his industry. As the deals and profits became larger and more visible, so did the media scrutiny and yes he did become a "scapegoat."
Your analogy to Donald Trump I believe is a little off simply due to the fact that RE and PE are two differnt industries and markets. While Trump now builds all over the world, each deal is in a local market with less peripheral participants. Thus if regulation or demands become unreasonable he can move to a more favorable market rather easily. Schwarzman, however, concentrates on the mega deal, which usually means it is hopelessly intangled with governments, bureacracies, and regulations, which are hardly the counterparties you want to deal with. His lavish parties have drawn the unwanted attention of the media and the government, (which is accountable generally to voters who WANT something) which he should have forseen. Many of his colleagues can afford the parties and the notoriety he enjoys, but they don't because they don't shit where they eat. Now the OCC has made generally unreasonable demands on Blackstone in their attempted ADS acquisition. Coincidence? Maybe, but I doubt it.
Point is Schwarzman has made his money and I respect that. Unfortunately, he has also drawn unwanted scrutiny on the PE industry, and for all of us on WSO who either work or want to work in the PE industry, he has made that harder. Deal scrutiny is now higher and it looks like within 2 years carried interest will no longer be taxed as capital gains. Oh well.
I-Banker2007, I like your train of thought and I agree with both yours and GameTheory's point of concern about the unwanted attention Schwarzmann has drawn.
The analogy to Donald Trump was made with a single thought in mind: if the media/public wasn't already so much against PE, Schwarzmann's behavior wouldn't bother anybody. I hope this makes sense. There are plenty of famous people with lavish lifestyles but it just so happens that their industry or field of business is not under constant attack so they get away with it; heck, they may even get complimented on a great party they threw.
I don't think Stevie S needs my protection on an online forum, but a lot of the public negativity towards PE is just solely based on the industry's ability to generate profits. I guess mediocrity will always rant against success.
This is a pretty extensive piece that I just found that covers a lot of what we talked about
http://www.newyorker.com/reporting/2008/02/11/080211fa_fact_stewart?dlb…
I read that yesterday (had a lot of free time at work, I guess...long story). Does a good job of painting Schwarzman in a good light. But it also seems like he knew what the party would do (from a public perception standpoint) and he did it anyway. I guess to my point, Peterson was discouraging it from the start.
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