Private equity firms spin off cash
By Matt Krantz, USA TODAY
They've bought Hertz. They've swallowed La Quinta and Neiman Marcus. They've even snapped up Toys R Us
and Dunkin' Donuts.
"They" are the wave of maverick investors and some-time turnaround artists storming Corporate America under
the banner of private equity.
What is private equity?
Investment firms that pool money from wealthy investors, pension plans and other institutional investors to buy or take a stake in
companies. These firms attempt to find ways to run companies better and sell them later for a profit. Private equity firms will often
borrow additional money from banks so they can buy companies and only use a small portion of their own cash. The firms were
commonly called leveraged buyout firms in the 1980s.
Private equity firms are arguably the hottest thing on Wall Street right now, packing the financial firepower to buy
all but the nation's largest companies. Their reach into the financial markets stands to transform the stock
market's landscape by putting a growing number of brand-name companies out of the reach of average investors
while also putting many retirees' pension and retirement funds into much more speculative investments than ever
Essentially a revamped version of the leveraged buyout firms of the 1980s, these firms buy undervalued or
underappreciated companies, fix them up and sell them for a fast profit, sometimes in as little as three years.
Their secret sauce is the use of debt — usually as much as 70 cents of every dollar they invest. Because they pile
debt onto the companies they buy, private equity firms free up their own cash, allowing them to make additional
investments and maximize their potential returns.
Their pitch, the cold-hard capitalistic mission of mining value from rusty companies, is causing excitement among
wealthy investors, pension plans and endowments, which are practically lining up to get a piece of the action.
"The money keeps piling in" says Chris Shepard, head of corporate finance at Imperial Capital.
And quite a pile at that. The amount invested in private equity hit $139.6 billion in 2005 and was twice as much as
in 2003, says Tobias Levkovich, strategist at Citigroup. That's more than the $135.8 billion that flowed into stock
mutual funds last year.
"The growing cash buildup at private equity investment houses may very well be the most important developing
financial force today," Levkovich wrote to clients.
Private equity also is luring brain and star power. Former General Electric CEO Jack Welch, Black Entertainment
Television founder Robert Johnson and U2 front-man Bono have all taken the private equity plunge. Welch has
joined Clayton Dubilier & Rice to help with strategic planning on operating companies, Johnson created a private
equity firm that will work with larger firm Carlyle Group, and Bono has joined the private equity firm Elevation
In the last year the big U.S. companies disappearing into the private equity fold included Neiman Marcus,
purchased for $4.9 billion in October; Toys R Us, bought for $6.6 billion in July; and computer services firm
SunGard Data Systems, for $11.3 billion in August. The biggest private equity deal in years closed in December
when a group of firms bought the Hertz rental car company for $15 billion.
If current trends persist, it could be just a matter of time before the biggest private equity deal of them all — the
$25 billion takeover of RJR Nabisco by Kohlberg Kravis Roberts in 1988 — is surpassed.
If all this seems familiar, it should. If you remember Barbarians at the Gate, Gordon Gekko and the leveraged-
buyout craze of the 1980s, you've seen the prequel to this story. LBOs are back, only they've rebranded
themselves private equity and are vowing a happier ending. Even many of the actors are the same, including the
big players in the '80s such as Carlyle Group, Texas Pacific and KKR.
As similar as the return of private equity might seem to the 1980s, the firms say this time it's completely different.
Instead of buying companies and dismantling them, as was their rap in the '80s, private equity firms install
experienced management teams that can squeeze more profit out of underperforming companies.
Critics say private equity firms are up to the same old tricks and are taking short-term profits without regard for the
long-term outlook for the companies they buy.
"Private equity firms have repeatedly extracted cash from companies knowing there was a significant risk they will
later run out of funds and be unable to raise more," says Gary Diamond, a restructuring adviser for Berger Epstein
While the two sides debate the pros and cons, one thing that seems pretty clear is that private equity's huge
popularity is having far-reaching effects. One of the most significant outgrowths of private equity is the attention it
is getting from public retiree funds. The flat returns from publicly traded stocks have driven giant public pensions,
which manage the nest eggs for teachers and other state employees, increasingly into private equity.
Buyout boom Last year, public
Several of the largest U.S. buyouts by private equity firms have occurred within the past 18 months pensions had
1.6% of their
Completed Acquiror Target Value* (in billions)
April 28, 1989 Kohlberg Kravis Roberts RJR Nabisco $25.1 invested in
Dec. 21, 2005 Investor Group Hertz $15.0 venture capital
Aug. 12, 2005 Investor Group SunGard Data Systems $11.3 and private
equity, twice their
July 21, 2005 Global Toys Acquisition Toys R Us $6.6
0.9% allocation in
Jan. 28, 2005 Zeus Holdings (IBO) Intelsat $5.1 2004, says
Oct. 6, 2005 Investor Group Neiman Marcus Group $4.9 Wilshire
March 3, 2003 Blackstone Group TRW Automotive (80%) $4.7 Associates. That
* — excluding debt Source: Dealogic, Capital IQ
might not seem
like much until
you consider that
public pension funds manage $2.1 trillion.
Private equity also has reduced the ranks of publicly traded companies from which individual investors get to
Key is competition?
Last year, there were 858 private equity buyouts of U.S.-based companies, up 62% from the 531 in 2004, says
Dealogic. In 75 of those cases last year, the private equity firm took a public company off the market, up from 60
That is one reason the overall number of public companies listed on the New York Stock Exchange and Nasdaq
Stock Market last year fell by 53 to 5,983.
Proponents say private equity firms help keep U.S. businesses more competitive. The threat of being bought out
keeps CEOs motivated and looking to boost returns, says Lewis Freeman, director of corporate turnaround firm
Lewis B. Freeman & Partners. "The private equity firms do (to companies) exactly what you do when you get
divorced after 20 years," he says. "You ... get rid of all the fat."
And there are successes. Consider VeriFone, which makes the boxes for cash registers to process credit cards.
The company lost money as a unit of Hewlett-Packard, says Alec Gores, chairman of Gores Technology, the
private equity firm that bought VeriFone in 2001. By focusing sales staff on selling VeriFone products, not
computers, things were turned around. "HP could have done the same thing if they decided it was a core
business," Gores says.
Gores sold VeriFone in 2002 to another private equity firm, GTCR Golder Rauner, for an undisclosed sum. GTCR
took VeriFone public in April 2005. By the end of its fiscal year in October 2005, the company had $485 million in
annual revenue — up 64% from fiscal 2002. Its stock has more than doubled.
Fees a concern
One common complaint is the fees some private equity firms charge and how they insure their payouts by loading
debt on the companies they buy, says Bill Parish of investment management firm Parish & Co. He calls the fees
scandalous. One of his criticisms is with a fee called "the carry." In a recent proposal to the Oregon pension plan,
for instance, Texas Pacific revealed it would get the first 20% of any cash generated by an investment after the
other partners' initial investment was returned, Parish says.
But that cash doesn't necessarily have to be the result of the companies in the portfolios doing well, Parish says.
A private equity firm can have a company in its portfolio take out a loan and use the proceeds from that loan to
pay the carry upfront. Then the private equity firm can lock in its payment no matter how the investment ends up
turning out for the other partners, Parish says.
Robert Schwenkel, head of the private equity group at law firm Fried Frank, says that characterization of the carry
is an oversimplification. He says, in most cases, private equity firms do not collect the carry until they sell an
investment for a profit and return the investors' original investment. Only then can the private equity firm take 20%
of the remaining profit.
Others are peeved at the fees private equity companies pay themselves. In May, rock band Linkin Park
threatened to stop making music because members were outraged that out of the $600 million raised by the IPO
of its label, Warner Music, just $7 million — roughly 1% — would go to Warner. Most of the proceeds were used
to pay dividends to private equity investors such as Bain Capital and Thomas H. Lee Partners and to repay some
of the debt that was piled on. By the time of the IPO, company insiders and executives had received more than
$800 million in bonuses and dividends, while the company still had $2.2 billion in debt, according to IPOhome.
Some investors have refused to play along anymore, says Francis Gaskins, editor of IPOdesktop.com. Paper
products company Boise Cascade filed to go public in February 2005 but was forced to withdraw its plans just
three months later. Investors didn't like that $2.4 billion in debt was piled onto the company by private equity
owner Madison Dearborn Partners, Gaskins says, and that the entire $288 million from its IPO was earmarked to
pay insiders, including private equity investor Madison Dearborn.
Despite the controversy, though, Allan Holt, co-head of the U.S. buyout group of Carlyle Group, says in the end
private equity companies are just another set of investors "looking for opportunities." He says private equity
investments will create more opportunities for public investors as the companies go full circle and return as IPOs.
Will the boom continue? That depends on whether the perfect setting for private equity continues, says Fentress
Seagroves, partner in PricewaterhouseCoopers' transaction services unit.
With more private equity firms bidding for companies, prices are rising, making it harder to make a big return,
Seagroves says. Meanwhile, there's always a threat banks will charge higher rates for the borrowed money on
which private equity thrives, eating further into returns. If returns aren't there, investors won't be either. If the easy
money is pulled away, the only private equity firms to survive will be the ones that don't "miss a beat," Seagroves
Private equity firm buys GE unit
Updated 9/15/2006 3:22 AM ET E-mail | Save | Print | Reprints & Permissions | Subscribe to stories like this
BIGGEST DEALS THIS YEAR
Biggest private equity deals this year:
HCA $21.0 July 4
Kinder Morgan $14.6 May 29
Univision $12.2 June 27
Albertson's $11.2 Jan. 23
GMAC $7.4 April 3
Aramark $6.3 May 1
Michael's Stores $5.9 June 30
Travelport $4.3 June 30
materials $3.8 Thurs.
Education Mgmt. $3.4 March 6
POSSIBLE BIG TARGETS
Morgan Stanley's Henry McVey says these companies
are the biggest possible targets for private equity
Mkt. value (in
Home Depot $77
Texas Instruments $48
Source: Morgan Stanley
By Matt Krantz, USA TODAY
The private equity assault on Corporate America continued Thursday as General Electric (GE) announced Apollo
Management is buying most of its advanced materials business for $3.8 billion.
As large as that price tag is, it ranked only ninth in a year that has seen a record blizzard of private equity deals worth
$173.2 billion, says Dealogic. Private equity deals, which were once known as leveraged buyouts, involve taking a
company private, loading it with debt and hoping to take it public again later at a profit.
This year's larger private equity deals have included HCA at $21.0 billion, Kinder Morgan at $14.6 billion and Univision at
$12.2 billion, Dealogic says.
Those could soon be dwarfed by a wave of monster-size going-private deals that one investment strategist says could
sweep up some well-known companies.
Morgan Stanley's Henry McVey says household names such as Home Depot and Dell could attract private equity offers
topping $50 billion in the next 18 months. He says a confluence of factors has created a "recipe" for a megadeal to occur,
•Languishing big-company stocks. The Standard & Poor's 500 has gained only 26.7% over the past five years, or 4.8%
a year. Meanwhile, the small-stock Russell 2000 has gained 74.2% or 11.7% a year.
Even CEOs bemoan their stock prices. "From this corner everything is up except the stock price," Philip Knight, chairman of
Nike, one of the 30 companies on McVey's target list, wrote in his 2006 letter to shareholders. "We are a long-term growth
company judged by short-term standards."
•Giant cash reserves. Public companies are sitting on so much cash and taking so few risks, McVey says. This makes
them attractive and easy targets, because buyout firms can use that cash to help finance the takeover. Cash at Analog
Devices, one of the potential targets McVey has identified, accounts for 61% of its total assets. Dell's cash has reached
37% of assets.
•"Club deals." Individual funds pool their money in "clubs" to afford even bigger targets. "It's like hunting in packs," says
Fentress Seagroves, a partner at PricewaterhouseCoopers. For instance, Home Depot, the biggest on McVey's list at $77
billion in market value, might be too much for one private equity firm to swallow but doable by several.
•Tax benefits. Private equity firms can buy large companies and shield their income from taxes, keeping more for
themselves as profit, by combining them with money-losing companies they already own, says Bill Parish of investment
management firm Parish & Co. Private equity firms, hungry to take advantage of this tax loophole, want larger targets. "The
bigger the company, the greater the tax savings," he says.
Posted 9/14/2006 9:39 AM ET
JANUARY 30, 2006
"OPERATOR, GET ME THE PRIVATE EQUITY TEAM LEADER"
If that call came in to your firm tomorrow morning, where would it go?
If the answer is, "anyone's guess," and if you consider your firm "a player," you have some
work to do.
Consider that at last week's Davos meeting of the "World Economic Forum," one of the
more outspoken hedge fund managers asked, "Why can buyout firms take public companies
private and make enormous returns, while the same type of returns seem out of reach for
public companies and their shareholders?" While the reasons for private companies to
outperform their public brethren are extremely complex, not to mention hotly disputed, the
market today (meaning the people who have billions at their disposal to invest) believe it so,
and are acting accordingly.
Just listen to The Wall Street Journal's year-end wrapup (for 2005, emphasis supplied):
"It was the biggest year for mergers and acquisitions since 2000, with $2.9 trillion in
announced deals, up 38% from a year ago, according to research firm Dealogic. The list
included Procter & Gamble's $60.8 billion buy of Gillette [...]
Dealing was also brisk in the technology sector, led by the $11.4 billion private-equity buyout
of SunGard Data Systems.... Private-equity firms racked up a record year, with $493.8
billion in deals, or 17% of total global volume. Nine of the 10 biggest private-equity deals on
record happened this year, according to Dealogic, including the $15.3 billion buyout of Danish
telecommunications firm TDC by Kohlberg Kravis Roberts, Apax Partners and others and the
$15 billion buyout of Hertz by Clayton Dubilier & Rice, Carlyle and Merrill Lynch Global Private
Look for more of the same next year, with private-equity acquirers hunting in packs, making
bigger deals possible."
No kidding about the deals getting bigger: "With some private equity funds raising as
much as $10 billion, the conversation has turned to whether there will be a day when a $100
billion fund arrives, fundamentally changing the landscape between public and private
But isn't there a limit to how large a fish private equity can swallow and still create the
out-sized market returns they've enjoyed so far? To the contrary: Some of the smartest
money is betting that "the next big opportunities [are] not in small companies but in big
companies, where the inefficiencies are writ large. As one big private equity investor said,
"The bigger the company, the better chance it is badly managed.""
O'Melveny & Myers chimes in: "The buyout funds are red-hot, having reached
So which law firms are getting the lion's share of this business? According to Bowne, in
North America last year the leader in buyout transaction volume (number of deals) was
Kirkland & Ellis (31) and the leader in total value of deals was Simpson-Thacher at just shy of
$16-billion. Other familiar names included Weil-Gotshal, O'Melveny & Myers, Latham, Cleary-
Gottlieb, and Ropes & Gray. In Europe, meanwhile, the volume leaders are Linklaters,
Clifford Chance, and Lovells, with 65 deals between them, and in value, Clifford Chance is #1
at nearly €19-billion, followed by Freshfields at €11.5-billion. US firms include the usual
suspects: Weil-Gotshal, Cleary, White & Case, Willkie-Farr, and Shearman and Sterling also
make respectable showings, solidly in the top ten in terms of deal value.
So my point would be?
Be nimble, be flexible, above all be aware of macroeconomic developments. Lucrative
practice areas do not materialize out of thin air; they are the creatures of capital flows around
the country and around the world. Five years ago hedge funds and private equity were
relatively somnolent, certainly in the public's eyes and even in the eyes of relative financial
The world changes, and the composition of its demand for top-of-the-pyramid legal
services changes in sync. Incumbents at the top today have no inalienable right to their
privileged status. On what more optimistic and energizing note could you conceivably begin
Posted by Bruce at January 30, 2006 09:39 AM | TrackBack
On The Cover/Top Stories
Neil Weinberg and Nathan Vardi 03.13.06
Driven by greed and fearlessness, private equity firms are the new power
on Wall Street. Investors beware: A reckoning is nigh.
Hamilton James is raising one of the largest private equity funds the world has ever seen, a $13 billion whopper
for Blackstone Group, renowned kingpin of the buyout business. Suddenly this thriving trade is redefining the
terms of power, profit and greed on Wall Street. He waxes rhapsodic on the benefits to the economy.
“Good private equity funds improve companies operationally and lower the cost of capital for those that are
financed inefficiently,” says James, president of Blackstone and chief of its private equity arm. Known as Tony, he
is a Harvard M.B.A. who ran investment banking at Credit Suisse First Boston before joining Blackstone in 2002.
As he wraps up fundraising for Blackstone V, investors are well aware of its predecessors’ home runs, with
Blackstone IV rising 70% a year.
“If you look at our record, or any good buyout fund’s record, you see consistent outperformance in good times and
Investors poured $106 billion into leveraged buyout funds last year, double the total of 2004, says Private Equity
Analyst. Weary of the wobbly stock market and alarmed by the real estate run-up, they were lured by eye-popping
returns of 50% a year (or better) at a few elite funds. Globally, 2,700 funds are raising half a trillion dollars in cash
to invest; this will bankroll them for $2.5 trillion in deals, given their penchant for putting $4 (or more) of debt
leverage atop every dollar they put up.
Just half a dozen giant firms control half of all private-equity assets. Three titans--Blackstone, Carlyle Group and
Texas Pacific Group--lord over companies with 700,000 employees and $122 billion in sales. Buyout shops own
such iconic brands as Hertz, Burger King, Metro-Goldwyn-Mayer, amc Entertainment, Linens ’N Things and more.
Adept at reaping riches whether their investors win or lose, ten buyout chiefs grace the Forbes 400 list of
wealthiest Americans. Among them is the billionaire cofounder of Blackstone: Stephen Schwarzman.
Egging on the buyout boys: all of Wall Street, which collects marvelous fees from all the buying and selling. While
it was making its own executives quite comfortable, Blackstone rewarded investment banks with $358 million in
fee revenue last year. Investment banks get fees for brokering or advising on tender offers; get fees for
underwriting bonds or arranging the bank debt to pay most of the acquisition costs; get more fees for selling off
some of the assets to pay back the debt; and get still more fees for taking target firms public all over again. Last
year saw $35 billion of public equity money raised globally as bought-out firms went public again. Underwriting
fees on those stock sales, plus all of the other fees generated by the private equity business, added up to an
$11.8 billion payday for investment banks in 2005, according to Dealogic. jpmorgan Chase collected $933 million
of this loot; Goldman Sachs scooped up $870 million.
There would be no reason to begrudge the financiers their take if they were building enterprises and creating jobs.
But they do not make their fortunes by discovering new drugs, writing software or creating retail chains. They are
making all this money by trading existing assets.
Some buyout firms dabble in deeds that got Wall Street and Big Business in trouble in the post-Enron era--
conflicts of interest, inadequate disclosure, questionable accounting, influence-peddling and more. Increasingly
the big guys jump into bed with each other. Last year buyout firms sold more than $100 billion in assets back and
forth to one another, 28% of all buyout fund deals are up fourfold in two years, says Dealogic.
Moreover, some buyout shops ply rape-and-pillage tactics at their new properties. They exact multimillion-dollar
fees advising businesses they just bought. They burden a target company with years of new debt, raised solely to
pay out instant cash to the buyout partners. It is akin to letting the Sopranos come in and gut your business to
cover your gambling debts.
BY THE NUMBERS
More politely known as a dividend recapitalization, this quick-buck ploy,
entirely legal, paid out $18 billion in instant gratification to new owners last
Biggest Buyouts year, Standard & Poor’s says. Now and again corporate carnage follows, as
thousands of employees lose their jobs, long-term prospects are diminished
Six of the largest private equity and the business files for bankruptcy, stranding minority investors and
deals ever—after KKR's 1989 debtholders.
colossal takeover of RJR
Nabisco—all went down last
Buyout funds defend brutal tactics by citing their results: They claim to beat
the overall market by five percentage points. But in fact they trailed the rise in
Deal the S&P 500 from 1980 to 2001, say professors Steven Kaplan of the
Target Value University of Chicago and Antoinette Schoar of the Massachusetts Institute of
Company ($bil) YEAR Technology.
RJR Nabisco $31.0 1989 Worse, their results could be headed for a slump as a huge influx of new
money and bidders inflates the prices of properties at a time when interest
Hertz 15.0 2005
rates could rise and increase the cost of new debt. Buyout firms are bidding
TDC 12.0 2005 “extraordinary” prices at frenzied corporate auctions, says Michael Gibbons of
Brown Gibbons Lang & Co., a Cleveland investment bank doing 25 such
SunGard data 11.4 2005 deals. “They’re going to have to assume very substantial growth rates to
systems justify it.”
Browning-Ferris 9.6 1999 “There’s a group of new private equity guys chasing deals for the sake of
Industries putting money to work,” says Darrell Butler of Billow Butler & Co., an
investment bank in Chicago. “They’re affectionately known as ‘dumb money.’
QWESTDEX 7.1 2003 They’re going to have a hard time when the economy turns, profits go south
and covenants get blown and banks come calling. And it will happen.”
Toys “R” Us 6.6 2005
neiman Marcus 5.1 2005
Metro-goldwyn- 4.9 2005
Millions of low-rollers--employees and taxpayers--could feel the impact. Pension plans provide 40% of the roughly
$600 billion now committed to buyout funds. Many pension plans, both corporate and governmental, are so
underfunded they look to private equity to help them close the gap, or at least to tell their actuaries that they can
close the gap. The stock market has gone nowhere for the past six years. How does a pension sponsor justify the
assumed 8% or 9% annual return on its fund? By putting a fairly large chunk of that fund in “alternative”
investments. It is taken as axiomatic that exotic investments will yield higher profits than plain old stocks and
Public and private pension funds overall have less than 4% of assets in private equity. But in a cruel coincidence,
underfunded pension plans and companies in bad shape rely more heavily on buyout funds than healthy firms do;
the sick ones need to jack up pension plans hurt by their own faltering finances. “Not only is the relationship
significant, it’s perverse,” says Stephen Nesbitt, chief executive of Cliffwater llc, a pension consulting firm. “Some
companies don’t want to take a hit to earnings or increase pension contributions,” so they load up on buyout
funds. Philadelphia’s city employee pension board, at only 59% of the funding it needs, aims to double its bet on
private equity to 11.2% of assets in four years. Eastman Kodak’s pension fund has 20% of assets in private
equity; Delta has 13%; ailing automaker General Motors is at 10%.
But if Darrell Butler is right--if too much dumb money is getting in at the top--the insiders who run funds will still
thrive. Private-equity funds typically take a 2% cut of assets annually plus a 20% chunk of everyone else’s profits.
If Blackstone is doing this--and it won’t say--it’s getting $260 million a year up front, on its new fund and one-fifth
of any upside. Warburg Pincus, Goldman Sachs Capital Partners and Carlyle rounded up $8 billion to $10 billion
each last year, ensuring hundreds of millions in fees even if they never produce a nickel of profit for anyone else.
This vigorish, common when a $1 billion fund was the norm, hasn’t come down even as buyout funds have grown
ten times as large. “It’s like Moses brought down a third tablet from the Mount--and it said ‘2 and 20,’” says
Christopher Ailman, chief investment officer of the California State Teachers’ Retirement System, the nation’s
third-largest pension fund. “We’ve been trying to get the fees lower, but it’s tough.”
lbo funds popped up in the 1980s, feeding on the junk-bond takeover craze. Blackstone was formed in 1985 when
Peter G. Peterson, a former Lehman Brothers chairman who had served as President Nixon’s secretary of
commerce, teamed with Lehman alum Schwarzman. They put up $400,000 and raised $810 million for
Blackstone I two years later.
The 1980s buyout binge peaked at 365 deals worth $99 billion in 1988. The era was immortalized in Barbarians
at the Gate: The Fall of RJR Nabisco, which profiled Kohlberg Kravis Roberts’ contentious takeover of rjr. At $31
billion in 1989 ($49 billion in today’s dollars), it remains the largest buyout on record. Six of the next largest deals
occurred only in the past year: Hertz ($15 billion, led by Clayton, Dubilier & Rice); Danish telco tdc ($12 billion,
Apax Partners); and SunGard Data Systems ($11.4 billion, Silver Lake Partners).
This time the boom is fueled by the pop of a market bubble. More companies are going private, frustrated by the
antifraud Sarbanes-Oxley Act. Thomson Financial counts 32 firms with a combined market value of $54 billion
that went private in 2005, up tenfold in three years. Banks, meanwhile, have loosened up lending to extend five
times as much senior debt as the equity put up by buyout funds.
Thus buoyed, buyout titans have done well grabbing underpriced, down-but-not-out businesses and whipping
them into shape: Texas Pacific with memc Electronic Materials; Silver Lake Partners with Seagate Technology;
Blackstone with trw Automotive. Their success has stoked ever more investor demand--never mind that buyout-
fund returns go down as money inflows go up (see chart, opposite).
“People think of private equity as Barbarians at the Gate, but we’re investors with tool boxes that can help
companies change capital structures and management strategies,” says James Coulter, a founding partner of
Investors with toolboxes? Germany’s Social Democrats described the Blackstone bankers who bought chemical
maker Celanese off the Frankfurt stock exchange in 2004 as “locusts.” The hedge fund Paulson & Co. claimed
Blackstone’s $650 million price was a lowball bid made possible only by a “fairness opinion” from its pals at
FACES BEHIND THE
Good Pay Goldman Sachs, which collected $21 million in fees from Blackstone last year.
Blackstone, unrepentant, took Celanese public on the New York Stock Exchange
The buyout business is so nine months after acquiring it, netting one of its funds a $3 billion profit (and that
profitable for those in doesn’t include shares it held on to).
charge that ten of its
chieftains made Forbes' Far less attention is focused on the flops and buyout funds’ sometimes central role
list of the wealthiest in same, albeit subsequent lawsuits have begun to surface. In one get-rich-quick
Americans last year. scheme, a dividend recap let Bain Capital turn an $18 million stake in faltering kb
Henry Kravis Toys into $85 million in cash--but left kb itself in much weaker shape.
Bain put up $18 million and took on $237 million in debt to buy the company in
December 2000. In April 2002 kb raised $66 million more in bank debt and used
$2.5 billion cash on hand to pay out $121 million in special dividends--$85 million for Bain and
$36 million for senior executives who signed off on the recap. But kb went on to
lose $109 million in less than two years, creditors say, filing for Chapter 11
George Roberts protection in January 2004.
Roberts Since then it has shut half of its 1,200 stores and laid off more than half of its
$2.5 billion 16,000 employees. Big Lots, the discount retailer that had sold kb Toys to Bain,
was owed $45 million but lost most of it in the bankruptcy filing. It has sued Bain for
fraud in Delaware state court. Bain, anticipating further opposition from creditors,
Stephen Schwarzman preemptively sued Big Lots to get a Delaware state court to explicitly endorse the
Blackstone Group recap; that case is pending. kb Toys was bought out of bankruptcy for $20 million
by another buyout firm, Prentice Capital. Unsecured creditors, who were owed
$2.5 billion $218 million, got only 8 cents on the dollar. In January they also sued Bain, in state
court in Massachusetts, charging it ginned up bogus fairness opinions in imposing
the recap. Bain blames kb Toys’ troubles on competition from Wal-Mart.
Platinum Equity The Equal artificial sweetener business has been through similarly sour times.
$1.7 billion Billionaire Michael Dell’s msd Capital and Pegasus Capital bought Monsanto’s
Equal business, Merisant Worldwide, for $600 million in 2000 by putting up $160
million in cash and borrowing the rest on Merisant’s assets. Three years later the
Thomas H. Lee new owners had Merisant borrow $206 million in new debt and pay the proceeds to
Thomas H. Lee themselves; months later they did it again, this time for $75 million. The two moves
Partners gave them a 76% profit on their initial investment, while letting them continue to
hold 100% ownership.
Merisant, with a negative net worth of $130 million and having spent $44 million on
Alec Gores interest in nine months, was forced to shelve an initial public offering last year. Its
Equal line is losing ground to Johnson & Johnson’s Splenda, which now has over
Platinum Equity half the market. Merisant is expected to post a loss for 2005, its third consecutive
$1.2 billion year in the red. In February Moody’s cut its credit rating to Caa3, its third-lowest
ranking. Pegasus and msd won’t comment.
Jerome Kohlberg These days nearly half the big buyout funds take their 20% slice from the dividend
Kohlberg Kravis recaps before their investors break even, says Karl Hartmann, chief operating
Roberts officer of Franklin Park, which advises institutional investors. Previously the funds
waited until outside investors (the limited partners) were in the black before
collecting their own cut.
Wilbur Ross Jr. Private-equity fund managers further cash in by charging their own portfolio firms
for everything from negotiating loans to helping run the business. Heartland
WL Ross & Co.
Industrial Partners, cofounded by David Stockman, President Reagan’s budget
$1 billion director, bought control of auto parts maker Collins & Aikman in 2001 for $260
million. Then it charged C&A $45 million for services and gave a cut to its limited
partners; often buyout firms pocket half the take rather than only 20% of realized
Nelson Peltz profits.
That may be all the partners ever get. Last spring C&A said it had violated accounting rules in booking sales, filing
for Chapter 11 soon after. It is shutting five U.S. plants and firing 975 people.
In other instances, buyout shops goose returns with “secondary deals”--selling their holdings to one another.
Simmons Co., a bedmaker, is the industry’s fruitcake, changing hands five time in 20 years. Now owned by
Thomas H. Lee Partners, it was forced to pull a public offering in 2004, yet the buyout firm gets a 1% cut of
Simmons’ operating earnings each year. For helping Simmons issue $200 million in new debt, the firm charged
Simmons $20 million plus expenses. Simmons received no cash from the offering; it all went to refinance old debt.
In another secondary deal, abry Partners last August paid $500 million to Providence Equity Partners to acquire
F&W Publications, a book and magazine publisher that Providence had taken private for $130 million in 2002. In
November 2005 abry filed a lawsuit in Delaware state court, claiming Providence had “engaged in various
fraudulent practices such as channel stuffing and other schemes to overstate (F&W’s) revenue.” Providence
In another recent case employees of Canadian Imperial Bank of Commerce accuse the bank of using a buyout
fund to rip them off. Former brokers James Forsythe and Alan Tesche say they and 490 colleagues invested $561
million, half of it borrowed, in a cibc fund in 2000. Since then it is down a shocking $420 million. In a lawsuit filed
in Delaware, they allege the bank used the fund as a “dumping ground” to pawn off “worthless investments” and
suck out $35 million in fees. Its holdings include Spectrasite, which went Chapter 11, and CityNet, a telecom on
which the fund took a 50% writeoff. cibc says the lawsuit is baseless.
When things go bad limited partners can look to a specialty firm that will buy out what’s left of their stakes--but
even in this game fraud can happen. “We’ve seen general partners convert funds to their own accounts, use them
for personal reasons and overdraw management fees,” says Frank Morgan, who runs the U.S. arm of London-
based Coller Capital, which has $2.6 billion in assets and runs the world’s largest fund for buying out limited
partners of other funds. He says such disputes happen more often than they should and usually are handled
But Coller itself went to court. Coller sued private equity firm Houston Partners in 2003 after becoming its top
investor. Coller sued the firm in state court in Texas, claiming Houston managing partner Harvard Hill Jr. had
made unauthorized distributions and loans to himself and his son and had set up secret fee arrangements with
related parties. The two sides reached an undisclosed settlement in August. Hill denies wrongdoing.
Other buyout firms come under fire for shrewd (or illegal) fundraising tactics. In Illinois a scandal erupted over
allegations private equity firms paid hundreds of thousands of dollars in bribes to coax investments out of officials
of the state’s teachers pension fund. A HealthPoint director recently pleaded guilty to federal charges of attempted
extortion in the scheme; a pension plan lawyer also pleaded guilty, and a board member, Stuart Levine, has pled
not guilty and awaits trial, charged with soliciting bribes.
Levine also plays a role in a second controversy, this one involving Carlyle, the Washington-based buyout
behemoth with $35 billion in assets. U.S. Attorney Patrick Fitzgerald in Chicago has issued a subpoena to the
teachers’ fund in the matter. After being spurned by the pension plan, Carlyle hired a local pol, Robert Kjellander;
he lobbied Levine on the pension board, and Carlyle landed $500 million from the pension plan.
Only later did pension officials learn that Kjellander had approached Levine and that Carlyle Group had agreed to
pay Kjellander a $4.5 million finder’s fee, says the pension plan’s executive director, Jon Bauman. The board now
bars such finder’s fees. Kjellander and officials at Carlyle insist they acted properly.
More such conflict-of-interest cases could arise as buyout funds harvest more retirement dollars from strapped
pension plans. Corporate retirement funds collectively face a $450 billion pension funding shortfall and are
throwing Hail Mary passes to private equity funds to close the chasm; likewise for public pension plans.
“I can’t think of an industry structure that’s more screwed up,” says one manager of a midsize buyout firm. “The
biggest suppliers of capital”--the pension funds--“are the most thinly staffed and underpaid,” he says. State plans
with a few employees oversee billion-dollar investments and report to “political entities--their boards--relying on
consultants whose business is mostly about marketing and politics,” he says.
They aren’t any match for the buyout guys--who already are anticipating a coming correction and are preparing to
profit from it. Some of the biggest names in buyouts--Blackstone, Carlyle, Apollo Advisors--now are raising
“distressed investment funds” (read: vulture funds). Feeding on big discounts, they will buy the equity and debt of
companies their brethren helped get into trouble.
March 27, 2006
A table in this story stated that Alec Gores is chairman of Platinum Equity. In fact, he is chairman of the Gores
Group; younger brother Tom Gores is chairman of Platinum Equity.