On Wall Street, So Much Cash, So Little Time (NY Times 24/6/10)
Only on Wall Street, in the rarefied realm of buyout moguls, could you actually have too much money.
David Rubenstein of the Carlyle Group, which is sitting on $18 billion. Buyouts have been scarce.
Times Topic: Private Equity
Private equity firms, where corporate takeovers are planned and plotted, today sit atop an estimated $500 billion. But the deal makers are desperate to find deals worth doing, and the clock is ticking.
The stores of money inside the private equity industry have ramifications far beyond the bid-’em-up crowd on Wall Street. Millions of Americans — investors, employees, retirees — have a stake in the game too.
Corporate buyout specialists generally raise money from big investors and then buy undervalued or underappreciated companies. To maximize investment returns, they typically leverage their cash with loans from banks or bond investors.
In recent years, private investment firms have amassed business empires rivaling the mightiest public corporations, buying up household names like Hilton Hotels, Dunkin’ Donuts and Neiman Marcus.
Critics contend that leveraged buyouts can saddle takeover targets with dangerous levels of debt. But unlike indebted homeowners, highly leveraged companies under the care of private equity have so far dodged the big bust many have predicted. After an unprecedented burst of buyouts during the boom leading up to 2008, a vast majority of these companies are hanging on. Whether they will avoid a reckoning is uncertain.
So for now buyout artists are searching for their next act. Public pension funds, university endowments, insurance companies and other institutions have pledged to invest many billions with them — provided the deal makers can find companies to buy. If they fail, investors can walk away, taking lucrative business with them.
Private equity funds generally tie up investors’ money for 10 years. But they typically must invest all the money within the first three to five years of the funds’ life. For giant buyout funds raised in 2006 and 2007, at the height of the bubble, time is short. They must invest their money soon or return it to clients — presumably along with some of the management fees the firms have already collected. Some of the industry’s biggest players, like David M. Rubenstein of the Carlyle Group, Henry Kravis of Kohlberg Kravis Roberts and David Bonderman of TPG, have more than $10 billion apiece in uncommitted capital — what is known as “dry powder” — according to Preqin, an industry research firm.
Some buyout firms are asking their clients for more time to search for companies to buy. Many more are rushing to invest their cash as quickly as possible, whatever the price.
Many in the industry are getting caught in bidding wars. Firms are assigning surprisingly high valuations to companies they are acquiring, even though the lofty prices will in all likelihood reduce profits for their investors. A big drop in returns would be particularly vexing for pension funds, which are counting on private equity, hedge funds and other so-called alternative investments to help them meet their mounting liabilities.
Given the prices being paid for companies, investors’ returns over the life of the fund are likely to drop into the low to mid-teens, said Hugh H. MacArthur, head of global private equity at the consulting firm Bain & Company, which used to be affiliated with Bain Capital, the private equity firm. Returns will be even lower once fees are factored in. Private equity firms typically charge an annual fee of 2 percent and take a 20 percent cut of any profits.
While investing in private equity will probably be more lucrative than investing in public markets, “those are far from the gross returns of the mid- to high teens that we saw a few years ago,” Mr. MacArthur said.
One factor in the modest forecast is rising prices for buyouts. Kelly DePonte, a partner at Probitas Partners in San Francisco, which helps private equity firms raise money, said “tough competition for deals” had driven up valuations recently.
One of the biggest and costliest deals so far this year was the acquisition of a stake in the Interactive Data Corporation, a financial market data company, by two private equity firms, Silver Lake and Warburg Pincus, according to Capital IQ, which tracks the industry. A third, unidentified private equity partner dropped out because the price was too high.
The two buyout shops paid $3.4 billion, or $33.86 in cash for each share of I.D.C. — a premium of nearly 33 percent to the going price in the stock market. Technology companies often command high valuations. Silver Lake and Warburg Pincus declined to comment for this article.
Last year, when banks balked at financing deals and private equity firms worried the economic crisis would drag on, the number of deals — and prices paid — fell sharply.
In July 2009, for instance, Apax Partners paid $28.50 a share, or $571 million, for Bankrate, which owned a number of consumer finance Web sites. The price represented a 15.8 percent premium. Apax had to pay the entire bill itself, with no money from banks.
But these days, even small and midsize companies are in a bidding frenzy. More than a dozen buyout firms made initial bids for the Virtual Radiologic Corporation, a company that interprets medical images remotely. Providence Equity Partners eventually paid a 41 percent premium for the company. When a small online education company called Plato Learning hung up a “for sale” sign, several suitors showed interest. When Plato last tried to sell itself, in the fall of 2007, it found no takers.
Private equity players concede that competition has heated up and prices are rising. But they argue that prices, from a historical standpoint, remain attractive. Prices are well below the stratospheric levels of 2007 and 2008, according to Capital IQ. Buyout executives also say it is too soon to determine what profits will come from these deals. And, they say, losers in bidding wars always claim the winners overpaid.
Still, those with dry powder are bidding aggressively, in the United States, Europe and Asia.
TPG — which, according to Preqin, has one of the largest stockpiles at more than $18 billion — has bid aggressively at several auctions, according to several investment bankers.
In fact, TPG has spent $9.2 billion so far this year, investing in 11 companies, including ones in India and Brazil. That makes TPG the industry’s top deal maker, according to Dealogic, a research firm. A spokesman for TPG declined to comment.
Noting that buyout firms are “feeling a lot of pressure to put the money to work,” William R. Atwood, head of the Illinois State Board of Investment, said he hoped the firms would not stretch too far for deals.
“There is a big counterpressure — a requirement for prudence and returns from their investments,” he said.