Private Equity Funds on the Rise

Doesn't it seem that there's been a resurgence of Private Equity buyouts of familiar public companies???

Readers Digest just agreed to be acquired for $1.6 Billion. 2005 was infact a banner year for corporate buyouts with targets like Hertz, Toys R Us, Neiman Marcus, La Quinta and Dunkin' Brands, the owner of Dunkin' Donuts. The targets keep getting bigger as more pension funds, institutions and wealthy individuals hand money to private-equity firms. I think even grocery chain Albertson's was bought by a team of investors for about $9.5 billion.

Some of the bigger Private Equity Funds are well known names like KKR, Apax, Blackstone and Carlyle Group. Here's what Wikipedia has to say about KKR

KKR helped develop and popularize the acquisition concept known as the leveraged buyout (LBO) by creating a series of limited partnerships to acquire various corporations, which they deemed to be underperforming. In most cases, KKR (often with management) financed up to twenty five percent of the acquisition price with its own capital and borrowed the remainder through bank loans and by issuing high-yield bonds, while having a more favorable approach towards the latter. KKR would often ensure that the target company's management retained an equity interest to create a personal financial incentive for them to approve of the takeover and work diligently towards the success of the investment.

The bank loans and bonds used to finance the acquisition were collateralized by the tangible and intangible assets of the target company. Because the bondholders only received their interest and principal payments after the banks were repaid, these bonds were deemed riskier than investment grade bonds in the event of default or bankruptcy, and popularly became known as "junk bonds."

Investment banks such as Drexel Burnham Lambert, led by Michael Milken, helped raise money for leveraged buyouts. Once the targeted company was acquired, KKR would help restructure the company, usually selling off certain underperforming assets and implementing a series of cost-cutting measures. The new, "leaner and more efficient" company could then be resold, often at significant return on investment.

While it sounds surprizingly neutral, KKR's LBO's were usually bad for individual shareholders. Read Barbarians At The Gate for an interesting account of how KKR successfully staged a hostile takeover of RJR Nabisco.

There are usually two exit strategies for a corporate buyout. Sell it to a big corporate buyer or floating it on a public stockmarket through an initial public offering (IPO). Earlier this year Burger King went public after having its costs reduced and being laden with debt! After dropping nearly 30% the stock is now nearly at IPO price!

Seems to be a pretty profitable business. However before you rush out and stick your money in them, while top few private-equity funds have actually beaten the stock market in the past few years, most of them did far worse after you factor in their fees. The total global market size of these funds was about $180 billion in 2004 so there are quite a lot to choose from.

And the Financial Services Authority[which is kind of like the SEC for the UK] even declared that the collapse of such leveraged-buyout firms was inevitable. Although to be fair, they don't just do leveraged-buyouts. They also provide venture capital, mezannine financing and growth capital.

Anyway, back to my original point. Doesn't it seem like we've been hearing a lot about private equity funds buying various companies and taking them private? Do you think the Sarbanes-Oxley act had something to do with it or is it just one of those cyclical things?