Thursday, October 12, 2006

Sherman threatens to burn down Greenwich too

With not much happening in the bond market, I though I'd comment on the swirling debate about whether private equity companies may be breaking anti-trust law. Nothing to do with bonds, you say? Hey, its my blog.

OK first, I'm not a lawyer. So I'm attacking this problem from the perspective of an economist. So the question is does the collusive activity result in economic harm? So it may be that someone has or has not broken the letter of the law, but for the sake of discussion, let's assume the law is actually related to real economic harm. Hey, its fun to pretend right?

I'll admit my biases up front. I normally have a dim view of anti-trust cases. The history of anti-trust law is full of examples of cases being brought against companies because their competitors complained, not because real harm to consumers could be found.

But let's take the case of private equity with an open mind. The query by anti-trust officials is about how private equity groups go about bidding on potential buyouts. As the linked WSJ article states, if buyout funds were colluding to say "I'll bid on this deal, you bid on that," then we have an obvious case of harm done to shareholders. Let's assume that isn't happening for a moment.

We know that companies contemplating going private can't hold a public auction for themselves. The terms are generally too complicated. Plus, a company may want to explore the possibility of going private without market scrutiny. Let's say that a company thinks it could go private at a 7% premium to the current stock price, but management believes that at some point in the future, a 15% premium could be commanded. If it became publicly known that the company was considering a buyout, shareholder sentiment may wind up forcing a (premature) move.

We also know that sometimes private equity targets a company. In that case, the private equity company isn't going to let it be known who they are targeting, so there isn't any chance for competing offers until after the private equity firm actually makes an offer. At that point, its possible that negotiations have been ongoing for some time, so the group that made the initial offer has a clear advantage over other groups trying to make competing bids. That isn't to say that another bid can't win, but that someone has an advantage.

No matter who seeks out whom, the incentives for both sides are clear. The public company wants the highest possible price, and the private equity wants the lowest possible price. So if a company looking to go private gets a poor price, its most likely a result of poor negotiation and/or a lack of awareness about what their company is really worth. Incompetence is not illegal.

Let's say two buyout funds were thinking of both making a bid for a company, but decided instead to join up and bid lower. I'm not sure whether that would be illegal or not under present statutes, but at any rate, it seems as though its still on the company to negotiate the best price possible.

If anyone disagrees I'd love to hear your comments. As long as the comment isn't something like "Let's take down the big, bad, private equity market."

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