VideoFive of the six largest buyouts were announced last year, including Equity Office; Freescale Semiconductor; HCA, with a price tag of $33 billion; Kinder Morgan, for $22 billion; and Harrah's Entertainment, for $27 billion. Even without including assumed debt, the proposed TXU buyout at $32 would top KKR's $31 billion acquisition of RJR Nabisco in 1988 as the largest LBO in history.
While such monster deals capture the imagination of Wall Street, making them pay off could be difficult. Even though few firms can play in the megadeal space, competition is still fierce, says Jeton. "We all gulp at the prices we have to pay, especially for these larger companies," he says. While Jeton insists that the inherent risk of a large deal going bad is lower due to the stability of such companies, the returns will also be diminished.
To make such deals work, private-equity firms know they need to do more than financial engineering. "Everyone will be able to get the same leverage we will, so people in our shoes have to say, 'What angle do we have, given the high price?'" says Jeton. That's why the buzzword among buyout firms these days is operations: winning bidders must have strategies that will create value by improving operations.
For this reason, the biggest private-equity firms are adding operations and strategy talent at a rapid pace. And it's not just Harvard MBAs they're pursuing. Celebrated CEOs and business leaders are becoming a fixture at buyout firms. Carlyle tapped former IBM CEO Louis Gerstner as chairman in 2003. The firm also lists former Securities and Exchange Commission chairman Arthur Levitt as an adviser. Clayton, Dubilier & Rice lists former General Electric guru Jack Welch as "special partner." Apax Partners went overseas for its rock star when it hired former BP CEO Lord John Browne.
Management star power is a key advantage of large private-equity firms, says Blackstone's James. "We're bringing a lot more than capital to the table," he says. According to James, Blackstone hires top specialists in different management disciplines to help out in nearly every situation. Few if any companies "could afford to have that kind of management talent at their beck and call," he says.
Jonathan Coslet, a senior partner at TPG, says that roughly a quarter of the firm's partners are on the operations side, and that number is growing. But he doesn't think the industry has as much operational expertise as advertised. "Only a handful of top firms really have that capability," he says.
Moreover, buyout firms may lack the operational expertise to fix the companies they buy. "In some cases, buyout firms count on changing the complacent culture of the company they buy," says Peter Morici, a professor at the University of Maryland. "But some of these companies are just too big to change." Morici adds that private-equity firms can easily overextend themselves: "PE firms run the risk of falling into the arrogant [belief] that they can make anything work."
A Quick Unraveling?
Most experts expect to see the trend toward larger deals continue — although the so-called club deal, in which buyout firms team up to buy a company, is currently under informal investigation by the Justice Department for possible antitrust violations. Going forward, it will be harder to make every deal work — even for a Carlyle. "We are going to have PE firms that lose all kinds of money," predicts Morici. "With the big successes will come a few huge failures."
For all the talk of the benefits to being private versus public, you won't hear many private-equity managers talk about a paradigm shift. "This is a cyclical business," says Bain Capital's Goss. "The best private-equity firms realize that and will deal with it accordingly. They are the ones that are in it for the long haul."
Some private-equity firms are looking to diversify beyond the buyout arena. Carlyle, for example, has investments in venture capital and real estate. Carlyle and Blackstone unveiled their first hedge funds in 2004, while KKR launched its first in February 2006. Many private-equity firms have also opened advisory businesses that help companies with restructuring or with their own deals. The firms hope that these businesses will provide a cushion during a downturn in the buyout cycle.
That's not to say that a bust is imminent. "I don't think there is a bubble," says James. "We are creating value in the economy for many different constituencies. As long as we continue to do that, [private equity] will continue to be robust." But even James doesn't think the party can last forever. "It's hard not to feel that life won't be this good forever," he says.
There are signs that shareholders, tired of watching private-equity firms flip companies for a 30 to 50 percent profit in one year, want to turn out the lights. In March, when Clear Channel management accepted a buyout offer from Bain Capital and Thomas H. Lee Partners for $18.7 billion, shareholders, notably Fidelity Investments, threatened to vote against the deal. In January, an offer to take Cablevision private by the controlling Dolan family and private-equity investors was rejected by independent directors, even after the offer was raised from $27 a share to $30.
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