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New Targets
Avoiding bad deals will depend on the supply of good targets, and there is plenty of debate regarding how many of those remain. Some observers contend that most of the low-hanging fruit — solid middle-market companies with low debt and healthy cash flow, but in need of some TLC — have already been picked. "There is so much money and so many firms chasing deals that finding [good targets] has gotten much harder," says Greg Peterson, transaction-services partner at PricewaterhouseCoopers.
The counterargument, advanced by numerous private-equity partners and industry watchers, is that the universe of viable buyout targets is expanding. That's because deep-pocketed buyout firms have the resources to go after bigger companies, and because they are increasingly looking overseas for new possibilities.
If you accept the notion that there is more value to operating as a private company than as a publicly traded one, then the number of potential targets increases still more. Talk to almost any private-equity manager these days and you will hear how difficult it is to be a public company. "Where we come from, we think the public model is broken from a governance and capital-structure standpoint," says Michael Goss, CFO of private-equity firm Bain Capital. At 2004's Private Equity Analyst Outlook Conference, KKR's Henry Kravis spoke of the disadvantages to public-company regulation. "To the extent that Sarbanes-Oxley causes public companies to be less competitive, there is an opportunity for the private-equity industry in taking these businesses private and putting some energy back into growing them," he said.
Private-company proponents also say that public-company shareholders are too focused on the short term and have little patience with long-term strategies. "Public-company managers are measured by a different standard," says Hamilton "Tony" James, president of Blackstone. "We make decisions that might not pay off for three to five years. You would get crucified as an executive if you did that in the public market." Adds Peter Jeton, chief operating officer of private-equity firm Apax Partners: "There are all kinds of things that can be done in a private-company setting that [managers] wouldn't dare do, or couldn't afford to do, in a public environment."
By this logic, virtually any public company could be a buyout target — meaning that the private-equity boom could continue indefinitely. And, in fact, private-equity firms are considering companies and industries they wouldn't have consider five years ago. "I can't think of even a modest swath of the economy that would be off-limits for private equity," says Jeton.
"They will not exclude anything," agrees Saikat Chaudhuri, an assistant professor of management at the University of Pennsylvania's Wharton School. "PE firms are looking at every company under the sun."
For example, big technology companies were once considered poor candidates for buyouts. They were thought to be too capital intensive, with cash streams that could be unpredictable. But in September 2006, Freescale Semiconductor agreed to a $17.6 billion buyout by a consortium led by Blackstone, Carlyle, and TPG (formerly Texas Pacific Group). And when TPG, along with KKR and Goldman Sachs, announced an agreement last February to acquire Texas utility TXU, conventional wisdom was dealt another blow — not just because the deal would be the largest LBO ever at $45 billion, but also because many figured that buying a large utility was unthinkable because of operational constraints imposed by state regulators. "God knows what is coming next," says Charles Ames, vice chairman at private-equity firm Clayton, Dubilier & Rice.
The typical buyout model of targeting companies with low debt, lots of cash flow, and plenty of fat to be trimmed is no longer the only one. "There are so many different models now," says PwC's Peterson. "It's all over the place, and it's surprising some of the things that people are looking at." He notes that buyout firms are looking at every opportunity, whether it's a turnaround, a growth opportunity, a real-estate-based transaction, or a bolt-on transaction.
Blackstone's February buyout of Equity Office Properties for $39 billion, including assumed debt, could signal the return of another model: the bust-up. Shortly after the deal closed, Blackstone immediately began to sell off parts of the real estate portfolio. "They had a lot of [resale] deals lined up before they were even done buying it," says Peterson.
Monster Deals
Whether or not such bust-up deals herald the return of corporate raiders and the hostile bids associated with them is unclear. But the recognition that no single type of transaction rules the day and that almost no company is too big to be bought out has created a wave of speculation on Wall Street over what will be next. The list includes prey as large as Home Depot, Dell Computer, Gap, Texas Instruments, and Chrysler. Such rumors can make life difficult for CFOs. In November, when word circulated that Home Depot could be an imminent buyout target, the price of the retailer's bonds dropped, which could negatively affect its credit rating.
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