Tuesday, January 30, 2007

Whither private equity?

The Wall Street Journal has printed three good stories on new developments in the private equity market, all of which suggest the salad days are waning.

This one indicates that the FTC is looking at large private equity funds more and more like conglomerates. This suggests that deals are going to go through greater anti-trust scrutiny, particularly among the larger funds. This could turn into a particular problem within certain industries which lend themselves more readily to going private.

Another article describes a classic principal-agent problem. In this case, CEO's may be pursuing deals with private equity without the board's knowledge, and therefore the deal could be worked out where the CEO benefits more so than shareholders. If a CEO is negotiating without the board's knowledge, you have to ask yourself why. In other words, if I'm a CEO and I think I have a deal which benefits shareholders, I'd go to the board with it. However, if the deal benefits me and not shareholders particularly, I'd probably keep it to myself. The principal-agent problem is probably the biggest issue facing capitalist economies today, in my opinion. Greed is good, as long as the greedy are only rewarded when they are productive.

A third article wonders if recent events surrounding the Clear Channel deal are a harbinger of things to come. In that case, some major shareholders are questioning whether they are really benefiting from the deal. Henry Ellenbogen of T. Rowe Price has a great quote, which is related to the principal-agent problem described above: "As a marketplace, you can't have an asset where people run it poorly, and put in incentives for them to cash it out at a lower price"

Anyway, I think most private equity deals work because the economics of the deal work. Those deals will continue to work, and private equity will continue to pursue those types of deals. However, it seems likely that boards will start asking for bigger and bigger premiums to get deals done. Its simple supply and demand. If you know that private equity has tons of cash it needs to put to work, it should follow that the price of doing deals will rise. As far as controlling CEO's, I think this is very much wrapped up in the compensation issue that has gotten so much press lately. Boards must become stronger and control the agents they hire.

No comments: