Valued Added: How Directors Can Rise to the Challenges of Private Equity

By Schmidt, Jamie | New Zealand Management, May 2007 | Go to article overview

Valued Added: How Directors Can Rise to the Challenges of Private Equity


Schmidt, Jamie, New Zealand Management


OVER the past few weeks we have seen Coles' potential disposal to private equity players in Australia, TXU sold in the largest private equity deal in the United States, private equity circling J Sainsbury in England and Telecom selling Yellow Pages to private equity in New Zealand.

Increased pension savings has provided significant funds looking for a reasonable return. This, in turn, has provided the private equity players with the liquidity to chase assets at the top end of town. No organisation can consider itself immune from attack on the grounds of its size. Through the use of arbitrage, financial engineering and active management, private equity investors aim to increase returns from their investments and eventually liquidate positions at healthy profits.

Directors of companies have a duty to maximise value for their shareholders. Private equity presents a number of challenges:

* While in the short term prices offered for business may well be in excess of current market value and represent gains to shareholders, it does beg the question how another owner can see more value in the business. A preferred target is one that could be described as "fat and happy". The balance sheet may have been allowed to become flabby and under geared and costs may be excessive. Private equity firms are well known for using financial leverage but also have been focusing on active ownership techniques to create value through cost reductions leaving no lazy manager or asset safe. With fewer compliance costs around public reporting, private equity also has a structural advantage over traditional industry players.

* The presence of private equity investors means the ability to grow the business through acquisition is diminished. Often they work a different type of model to the one applied by trade buyers with lower hurdle rates and considerable weighting given to exit values. Private equity often wins in the competition, which is surprising as they frequently have less to gain from synergy or market gains.

* Increasingly, private equity is seen as the employer of choice with financial rewards for hard work in an exciting environment with less compliance. Key management are often incentivised through shareholdings and options which can provide healthy profits when the exit strategy is executed. …

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