Let Us Now Praise Private Equity

Buyout bosses manage companies that outperform their publicly traded peers on key measures of growth. And they don't do it just by cutting costs.
Kate O'SullivanSeptember 1, 2008

The public’s perception of private-equity firms is all wrong — at least according to a new study from Ernst & Young.

Often viewed as hard-hearted financial engineers who pile up profits by slashing expenses, P-E kingpins are criticized for their lack of transparency, their much-debated tax status, and, of course, their lavish lifestyles. But a new report offers support for the same case that P-E bosses often make for themselves — namely, that they are not only shrewd investors but also talented managers.

The study examined last year’s top-100 private-equity exits in North America, Europe, and Asia, using publicly available information and self-reported data gathered in interviews with private-equity investors. As it turns out,
P-E firms helped their portfolio companies achieve an average enterprise value growth rate that was double that of their publicly held peer companies.

Private-equity-backed businesses outperform public companies in productivity gains, in employment growth, and in business expansion, measured both in terms of enterprise value — the company’s market value plus net debt — and earnings before interest, taxes, depreciation, and amortization, according to John O’Neill, Americas director of private equity at Ernst & Young. “We found that probably only a third of that growth is from cost-cutting,” he says. “More than 50 percent is organic growth, and the rest is acquisition-related.”

By making quick decisions free from the scrutiny of public shareholders, installing and motivating the best managers and workers, and sticking rigorously to their business plans, P-E firms “are selling better businesses than they bought,” says O’Neill.

The study found that even when private-equity investors take the “secondary buyout” route — selling a portfolio business to another private-equity player — the new owner manages to unlock further value. So why did the first firm sell it? “Once they find a buyer at the right price, they’re going to sell the company,” says John Vester, a principal in E&Y’s transaction advisory services group. “They don’t fall in love with the deal.”

Private-equity versus public-company growth in 2007