A Sign of the Top for Private Equity?

If the Blackstone Group ever goes public, it sure would be cool to get an allocation of the IPO. Imagine your clients at cocktail parties, bragging about how they are “in” enough to have gotten a piece of that deal. (Sure might help you recruit new clients.) But, one wonders, if Blackstone co-founder Stephen Schwarzman is selling, do you want to be buying? Put another way, the news that buyout behemoth Blackstone Group is mulling an IPO may be “a sign” that this rather secretive market segment may be peaking.

If the Blackstone Group ever goes public, it sure would be cool to get an allocation of the IPO. Imagine your clients at cocktail parties, bragging about how they are “in” enough to have gotten a piece of that deal. (Sure might help you recruit new clients.) But, one wonders, if Blackstone co-founder Stephen Schwarzman is selling, do you want to be buying? Put another way, the news that buyout behemoth Blackstone Group is mulling an IPO may be “a sign” that this rather secretive market segment may be peaking.

After all, Schwarzman has been complaining that the cost of capital for private equity groups has been rising. Of course, that’s not surprising, especially given all of the M&A activity. Liquidity has been flowing into the sector from pension funds and other institutions that are seeking fatter returns than can be had in the stock market. The private equity market has been piping hot for the last five years, but could it be getting a little too overheated? Is there too much money chasing too few good deals?

Indeed, the largest-ever private equity buyout was inked in early February when Blackstone took control of real estate company Equity Office Properties for $23 billion in cash, plus its $15.9 billion in debt. After waging a three-month bidding war with rival Vornado Realty Trust, Blackstone secured the deal when Vornado bowed out saying the price was not in its shareholders’ best interests. The blockbuster deal followed previous record holder Kohlberg Kravis Roberts (KKR), which engineered a $33 billion takeover of hospitals operator HCA in November.

“The conditions for the big buyout firms the past few years have been ideal. But they’re not going to continue forever,” says Jennifer Rossa, managing editor of the Private Equity Analyst, a private equity newsletter published by Dow Jones. She says that “cheap debt” and “low interest rates” have been key drivers for buyout activity during this period but that industry watchers are wondering whether this climate is sustainable. Andy Brusman, a managing director at Westham Capital Partners, says, “It’s possible that the private equity market may be too built up.”

In general, the sponsors of private equity deals aim to optimize the return that equity holders get as a result of improving the performance of the business. They tend to target companies with consistent long-term earnings prospects or companies that need restructuring, which can be a daunting task in the public markets. A lot of smaller companies either can’t afford to be public due to regulatory constraints such as Sarbanes-Oxley, or they simply choose not to deal with the headaches of quarterly earnings, which are often tied to short-term movements in the share price.

Blackstone, with an estimated worth of more than $20 billion, could file for an initial public stock offering within two weeks, according to a broadcast last Friday on cable television network CNBC. The New York-based firm, famous for taking companies private, is considering whether to sell stock in an IPO that would be led by Goldman Sachs. The timing of the IPO could mean that BlackStone CEO Schwarzman thinks that his company will fetch the highest price right now and enable him to take home a sizeable chunk of change for himself. And going public provides liquidity and enables the firm to monetize its operations for some of the other executives. “People tend to sell when things are good,” Rossa says.

However, it’s a curious move in that such a staunch proponent of operating a company as a privately held entity is considering taking his firm public. After all, Schwarzman has repeatedly stated that companies perform better when working for his buyout firm as opposed to public shareholders. The freedom from regulatory scrutiny, the financial rewards for its management team and the ability to avoid quarterly earnings reports are just a few of the reasons Schwartzman advocates privatization. He also preaches about having a long-term view of the market and using cash flow as a gauge of company’s fiscal well being instead of profits, which have been proven to be vulnerable due to being fudged.

“You have to see some irony there,” says Westham Capital’s Brusman. Firms that tend to keep things very close to the vest, like hedge funds and private equity firms, are launching IPOs, he says. But BlackStone may structure its IPO in a way that allows the company to retain the cloaked nature of private equity. Blackstone could do what’s known as a master limited partnership that would effectively allow investors to share in the fees and profits without much added disclosure on things like executive compensation packages.

Private equity certainly has a lot of cachet right now and one industry observer doesn’t see the spate of activity easing any time soon. “It’s a very attractive asset class to all investors,” says Dominick DeChiara, a partner and leveraged buyouts practice group leader at Nixon Peabody. Even though firms like Fortress, KKR and Blackstone grab all the headlines, there’s a lot more activity and competition at the $500 million to $1 billion level. “At that level, the market is still extremely frothy,” DeChiara says. So while a BlackStone IPO may be a clue that the private equity market has peaked, there seems to be plenty of activity that would suggest otherwise. “Many people are waiting for a correction but, then again, they were saying that two years ago,” Brusman says.

And the fun of it all, is that Schwarzman once said: “The public markets are overrated.” Unless, of course, you can mark up the value of your company because investors are, for the moment, hungry for anything private equity.

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