Private equity has been getting a barrage of popular press coverage, due largely to mega-deals for companies like HCA, Aramark and VNU (Kinder Morgan, for whatever reason, keeps being treated like a middle child). Most of said coverage, however, seems to have been assigned by unimaginative editors who want to know either: “Are large fund sizes driving large deal sizes?” or “Is this a bubble?” Important questions to be sure, but also ones that this space and others have been asking – and answering affirmatively – for well over a year.
So it was with appreciative surprise that I read James Surowiecki’s latest New Yorker column, in which he argues that management buyouts are fundamentally flawed. In short, he uses academic studies to claim that MBOs present an unavoidable conflict of interest between management and shareholders, with the former wanting to keep the sale price low (since they’re participating) and the latter wanting to raise it higher (since they’re exiting). Moreover, Surowiecki wonders if many MBO-backed companies wouldn’t have been better off staying public, and then instituting similar asset sales or leverage restructurings. Independent directors, of course, are supposed to navigate such conflicts, but Suroqiecki correctly points out that they often are appointed by their senior management pals.
What makes this piece mandatory reading is that it runs counter to conventional private equity wisdom, in which management buyouts are morally preferable to hostile takeovers. In fact, it slaps such wisdom in the face. So I ask you, dear readers, to take a look and then let me know what you think. My overall opinion is that his arguments are compelling, but I also can find a couple of trouble-spots:
*** Where is the anecdotal evidence that independent directors are not acting as proper fiduciaries? HCA’s special committee, for example, intentionally kept the door open for a higher bid, by preventing KKR/Bain/Merrill from syndicating their equity with other large private equity firms (i.e., prospective bidders). He does write that Aramark got a little more value after shareholders complained, but then dismisses the additional $1.80 per share as insignificant. If this is so little money, how come both TH Lee Partners and Carlyle dropped out of the SunGard deal last year after the bidding rose from $34 to $36 per share?
*** Surowiecki does not give much weight to the operational expertise of LBO firms. I’ve been a major critic of LBO firms writing management contracts with their own portfolio companies — because such responsibility should be automatically assumed – but I also understand that portfolio companies usually benefit from LBO firm involvement. Bain, Blackstone, KKR, etc. have all been through countless subsidiary spin-offs/sales, leverage recaps and senior management searches. Most corporate boards have been through just a few, if that.
Surowiecki also compounds this rhetorical failing by suggesting that the main benefit of going private is the private status itself. In other words, companies go private to avoid regulatory headaches, Wall Street expectations and a vast sea of owners. No mention of how a company might really want someone like TPG’s James Coulter as an active director.
To buttress his point, he asks why more companies don’t stay private. I believe this is the wrong question (again, because it ignores LBO firm value-add), but also must point out that more and more LBO-backed companies are, indeed, staying private. Part of this is thanks to a lousy IPO market, while another part is that LBO firms have become far more comfortable with sponsor-to-sponsor sales. Certain deals need to be exited publicly (HCA, SunGard, etc.) because there aren’t many viable buyers, but staying private has become a far more acceptable option.
Here’s that link one more time. What say you?