Friday, July 22, 2005

It's No Longer Hip to Be Public, Dude: The Rise of Private Equity

I was speaking to a guy today, young guy right out of college.

Guy lands an Investment Banking associate gig at Bank of America straight out of Stern.

Two words kept coming out of his mouth: Private equity.

Private equity is all the rage nowadays.

Wall Street is recruiting less MBAs for straight investment banking jobs - everyone wants to go straight into private equity.

If it's not private equity, it is hedge funds.

Private equity simply refers to equity that's made available to companies or investors but isn't quoted on a stock market.

I believe hedge funds ruled the first 5 years of this decade.

For the next five, private equity will be delivering the most promising results (not that hedge funds showered their investors with staggering results) and basking in most of the limelight.

Here is why.

There is a huge market for private equity groups to operate and create value.

ESL's taking over K-Mart, for instance, has sent the stock to the moon.

Today's private equity firms are no longer the ravenous, debt-loading LBO practitioners that they were in the 80s.

Today, private equity firms are smarter.

They're getting their feet wet in everything from politics to philanthropy.

Essentially private equity firms can be broken down into 2 groups.

The first group includes venture capitalists, which we profiled earlier this week.

VCs finance companies that are just starting out but have so far been able to collect revenues and bring respectable, seasoned management on board.

At least that is how it works in theory.

During the boom, VCs got a bit greedy and decided they'd fund anything with in its name.

The other private equity group includes buyout firms.

These are the sort of firms whose founders buy $37 million dollar apartments in Manhattan (partners are compensated with a management fee, as well as a carried interest, defined as a percentage of profits generated by the fund).

The big cats include the The Carlyle Group, Blackstone, and KKR.

Buyout firms love to take over distressed companies, especially those that are undervalued by other investors.

Later on, they'll seek a return on their investment by either selling it to a corporate giant or floating it on the open market via an IPO.

And because private equity firms and the companies they own are shielded from the glare of attention --in contrast to publicly listed companies -- they can really get their nails in the dirt and go to work rather than worry about what short term over-reactions the capital markets may punish them with.

Markets tend to over-react to extremely short-term news, anyways.

Private equity is the antidote.

The heads of private equity firms are in full control of the managers who run the companies in their portfolio and they only have to answer to a small group of investors.

Hostile takeovers are more 1985, 86.

Today, troubled companies are actually seeking out private equity firms for their uncanny and sage advice.

As Henry Kravis, the grandfather of private equity concedes, "...since the days of buying a company on the cheap are pretty much over, and the key driver for success in our business is what you can do with the company after you own it."

Hedge funds, even more, are investing part of their assets in private equity.

While the average individual investor will not have access to private equity because it requires a very large investment, Wall Street's top players will have no way around these new Kings of Capitalism.

You just see.

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