The Enigma of Private Equity; Do Leveraged Buyouts Permanently Improve Companies and Ultimately Raise Living Standards? or Do These Deals Merely Enrich the Already Rich?
Samuelson, Robert J., Newsweek
Byline: Robert J. Samuelson
Pictured recently on the cover of Fortune, Steve Schwarzman is "the new king of Wall Street," says the magazine. Schwarzman heads the Blackstone Group, a big "private equity" firm. In capitalism's toolbox, private equity is the latest socket wrench. It's made many people rich. In 2006, Forbes put Schwarzman at 73 on its list of the 400 wealthiest Americans, with a fortune of $3.5 billion. The question is whether private equity is good for the country.
Modern capitalism is a study in contrasts. On the one hand, it's dominated by massive enterprises that tend to become high-cost bureaucracies. On the other hand, these giant firms are increasingly policed by activist shareholders--including private-equity firms--that focus single-mindedly on profits. To its champions, private equity forces companies to cut costs and improve efficiency; profits are deserved. To critics, profits flow mainly from loading companies up with debt; private equity is a sophisticated swindle that often cheats ordinary shareholders.
Let's start with the basics. Private equity refers to the practice of groups of investors--private-equity firms--buying up all the publicly traded stock of target companies. These companies are then said to "go private." Usually, this is done with much borrowed money, explaining why this same process in the 1980s was known as "leveraged buyouts" (the leverage referring to borrowing), or LBOs. By whatever name, the buyouts are booming again. In 2006, private-equity firms bought 654 U.S. companies for a record $375 billion, says Thomson Financial. That was a quarter of all U.S. mergers and acquisitions last year, and 18 times the level in 2003.
Nine of the 10 largest buyouts have occurred in the past year. The list includes many familiar corporate names: HCA, the hospital chain; Harrah's Entertainment, the casino firm, and Univision, the Spanish-language TV network. The pace may pick up, because money has poured into private-equity funds, managed by companies like Blackstone, Kohlberg Kravis Roberts & Co. and the Carlyle Group. Investors in private-equity funds include wealthy individuals, insurance companies, college endowments and pension funds. The present boom stems from ample cheap credit and the prospect of big payoffs. Over the past 20 years, buyout firms have averaged annual returns of 13.2 percent, says Thomson. By contrast, the stocks in the Standard & Poor's 500 Index have averaged only 9.7 percent.
But how are these superior returns achieved? Are companies permanently improved--a process that would ultimately lead to higher living standards? …