Cracking A Window On Portfolio Company Valuations

Interesting, isn’t it, how LBO sponsors may put widely varying values on the companies they take private?

The New York Times had an interesting exercise in its business section today evaluating the valuations that different buyout firms put on their portfolio holdings.

One example is the Texas electric utility Energy Future Holdings Corp., owned by buyout firms including Kohlberg Kravis Roberts & Co., TPG Capital and Goldman Sachs.

The company was taken private in 2007 in a deal valued at $48 billion—the largest in the history of private equity. K.K.R. now values its investment at 20 cents on the dollar; TPG values its stake at twice that, 40 cents. That gap represents a difference of nearly $1.7 billion in the value of each firm’s equity stake.

It almost makes you wonder if these sponsors were looking at the same company.

The story also has details on chipmaker Freescale Semiconductor and casino operator Harrah’s Entertainment, among others. This apparently was based on a leak of data provided to the newspaper by an investor—or somebody else with access to the reports that the GPs deliver to their LPs. (Incidentally, anybody who wants to strike a blow for transparency can send secret stuff to my e-mail address, which is also at the top of this page right below my smiling face.)

It is fair to ask how much of this really matters. The deals involved in this exercise were, in the main, done more or less at the peak of last decade’s asset bubble, and it’s vague how current these discounted valuations are. Post crash? The focus is also on companies with known problems in highly volatile industries—energy, technology, gambling—without mentioning, say, a First Data Corp., a payment processor with more stable revenue flows that might not show such divergence in sponsor valuations.

I am not particularly a fan of so-called “fair value” accounting. I think it’s misleading to take long-term holdings and mark them to market every quarter. In both boom times and busts, that approach can make matters worse by causing the pendulum to swing more widely. In the midst of the financial crisis, for instance, in March 2009, Congress pressured FASB to back off fair-value rules involving bank loans. The plunge in bank stocks ceased immediately, and the crisis abated. (Tom Brown, a hedge fund guy whom I greatly respect, makes a very articulate argument about this issue. While he’s talking about banks, the same principles clearly apply to buyouts.) Even the Times admits that these interim valuations have the same kind of significance as “the score in the fifth inning of a baseball game.”

All that being said, I like the idea of broader disclosure of portfolio company valuations, especially for publicly traded buyout shops. A lot of business development companies do it, including BDCs that are affiliated with buyout firms. (BDCs are closed-end funds that sell stock to the public and typically invest in debt, often of sponsor-backed borrowers.) Here, for instance, is the schedule of investments from Apollo Investment Corp., an affiliate of Apollo Global Management.

It’s one thing if your private equity firm is really private, accountable only to its accredited investors. But when the firm sells stock to the general public, it takes on a fiduciary responsibility to a much broader group. And even if the information about portfolio company valuations is mainly useful as a comparison of sponsors’ irrational exuberance, it seems like investors ought to have a right to know that.