Thursday, October 18, 2012

Private Equity: Too disruptive or not disruptive enough?




1. Why private equity? 

2. Who are these PE investors? 

3. PE winners and PE losers


4. Is PE a net social good or social bad? 




Anonymous said...

There is a good piece on this subject by David Stockman in this week's Newsweek.
"Mitt Romney: The Great Deformer"

From his forthcoming book:
The Great Deformation: How Crony Capitalism Corrupts Free Markets and Democracy due out, alas, past Nov-6th .. in March 2013.

Jean-Florent Rérolle said...

the link to your presentation does not work

Anonymous said...

What is the relative performance of similarly levered public investors??

Anonymous said...

I cannot hear half of the conference... there seems to be a problem with the microphone

Abhinav Tripathi said...

The link to the presentation is not working.

Jason DaCruz said...
This comment has been removed by the author.
Jason DaCruz said...


I would add to your first point on "Why private equity" the information problem. PE shops can really tear through the books of a company. It may be costly (lawyers, accountants, due diligence consultants), but at least it is an available option. This idea ties happily to your previous post on financial disclosure.

As for the treatment of carried interest - the arguments for a break in taxes on capital gains v ordinary income are two fold: 1) it increases the amount of funds available to fund projects and 2) it encourages individuals to save.

I would be inclined to say that 1) is a general market distortion. In theory, the markets should do a fine job in smoothing capital allocations between the present and future. However, 2) may provide evidence that individuals are not always rational in their present v future consumption choices. Or, at the very least, they overestimate their earnings stability - especially for lower income individuals.

That last point - 'especially for lower income individuals' - provides the only justification for social engineering that I can see. A tax break on capital gains up to a certain point would stay true to our beliefs that markets, on average, are right while protecting individuals from a lack of savings.

Unfortunately, the above sounds like a political statement rather than an economic one...


Aswath Damodaran said...

Like you, I am not a fan of using the tax code for social policy but my point on carried interest is a simple one. Since it is an "excess" payment to general partners, over an above their capital contribution to the buyout, that excess payment has to be for something other than providing capital (which is the basis for your argument that it encourages savings & investment). What do general partners bring in besides capital? They are skilled at targeting the right companies, getting the information about them (as you rightly point out) and turning them around. All of these are very worthy "value added" actions, but they are "income" generating actions that come from skill, not the capital investment. I personally think that PE investors will be well served conceding the carried interest argument and fighting on other fronts.

Anonymous said...

I guess you have to have lived and worked in the PE environment to understand and feel the real difference in leadership under Public and Private financing. Often, ownership is shared between different PE firms and it would have been interesting if you would have digressed on that point. In addition, ownership may change hands between PE firms. It would be interesting to understand how valuation is established when ownership changes under private capital.

Aswath Damodaran said...

Let's start with your premise. Let's assume that firms under PE experience a change in leadership and that is what accounts for success (I think that PE investors range the spectrum from very effective to completely ineffective). If carried interest is the payoff for leadership, it still does not take away from my point, which is that it is not a return on capital but a return to skills (income).

Anonymous said...

Aswath Damodaran,
A company under PE usually goes through two phases. The first phase is one of restructuring to make it ready for growth, usually taking 2-3 years. The second phase or growth phase is to maximize value to get the company ready for sale. These two phases take different skills and often you see a change in weighting of the owners during the phase transition. In the second phase, the owner with the largest share usually takes the lead in maximizing value to bring the company up for sale, often in an auction but also through an IPO or a sale to another conglomerate of PE’s, and the process starts all over.

I understand your premise that there are good and bad PE’s, like there are good and bad academic environments. What I was interested in learning is how you would think valuation works in the second phase of a company under private rather than public capital. So, when a company is ready to change hands from one group of PE to another group of PE, a price is negotiated for the sale. How does the underlying valuation work in that sale?

Jan Dil
The Netherlands

Jason DaCruz said...

Professor -

Sorry I didn't check in for your reply; I hope you get a chance to see this.

I think I misspoke when I left my commment - I meant to say that the carried interest tax treatment doesn't fall into either of my reasons for general preferential treatment of capital gains under the tax code. I am in agreement that PE should throw in the towel on their favorable tax status.

Jan Dil and a couple others were interested in learning more about these company valuations. I've worked with a few PE shops and have a basic understanding of how they forecast revenue and expenditure growth (usually through discussion with management and a rigorous analysis of their assumptions) for the holding period. Most of them then use earnings multiples -- usually the lesser of their own acquisition multiple or multiples of comparable companies -- to calculate a divestiture value.

I am very interested in understanding the capital structure analysis that goes into valuing these companies, though. What makes a good 'distressed' investment? Are these mostly management turn-arounds or is there a financial component?

charlesgraves said...


Financial Directory said...

Private equity is nothing more than a blood sucking way to drain the life and vitality out of a company in order to make a fast buck. Buy a company using lots of leverage. Along with some dirty little tricks like buying quietly a majority stake in a company behind everyones back without making a tender offer along with and including buying the shares at a big discount to what they are actually worth without declaring your intentions' to deceive investors. Than declare that your taking the company private and offer as little as possible for the remaining shares which are worth twice as much money as your offering for them and than say your saving the company what a bad bad joke. These private equity firms will do anything to come out ahead on the bottom line. Like sell all the real estate a company owns' sell or loan out patients and copyrights' tradmarks' pit one state against another threatening to move a division of their company to another state if they do not receive a subsidy or some generous tax breaks. Sell off divisions of the company that are undervalued. Fire as many workers as they possibly can' along with cutting the wages and benifits of the remaining employees to increase the bottom line. Squeeze price concessions from loyal vendors that are heavely dependent on a large part of their sales to your company. Tell your unions its take drastic cuts in wages and benifits or else risk having your plant shut down. And finally when you bring your company public again hire that so ethical investment banking firm goldman sachs to overhype the value of your public offering to increase the amount of money you will receive when the company becomes a public company again and at that point you bail out of the stock leaving a company torn into pieces from what it originally was.

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