Tuesday, May 29, 2007

A Few Thoughts on the Private Equity Phenomenon

Private Equity is not going away. It will continue to grow and 10 years from now, we will think of it as just being another money management vehicle along side mutual funds, exchange traded funds, managed accounts, etc. Whereas mutual funds began as a way for small investors to improve diversification and have access to professional money managers, private equity funds are a means for institutions and the very wealthy to have access to more of a "hands on" business arrangement with corporate America. It is just another means of owning equity. As I have mentioned previously here, there is a growing feeling that a kind of imperial attitude has sprung up in corporate America. Corporate chieftains have figured out that they answer to everyone, while at the same time, answering to no one, and little by little they have begun to take advantage of their positions in ways that are increasingly unacceptable to many investors. I could not have imagined that this sort of imperial attitude would have become apparent so soon after the Enron fiasco, but $100 million dollar retirement packages for CEOs have become a way of life, with no end is in sight. I have always said that big money thinks and acts differently -- that's how they become "big money." I have a friend who is in this category. When he owns a stock, he will own several million dollars worth. He genuinely thinks that the CEO and the board of directors work for him ( he usually owns more stock than any of them), and if they act in ways that do not suit him, he does not cut bait and try another stock, he will pay the CEO a visit. He does not rant or rave, he just advises the person that he is unhappy, and he expects things to change. He usually has a list of things he does not believe are being handled well, as well as a list of costs that he believes are out of line. He asks for explanations, and if the answers are either not forthcoming or are evasive, he advises the CEO that he will attempt to change the make up of the board. I used to cringe every time he started off on one of his campaigns, but I have come to see things more his way. There are too many boards of directors who are not looking out for the good of the shareholders they are supposed to represent. They are only riding the gravy train just like everybody else. There are too many boards of directors who are not properly supervising their firms' strategies or top managements. They are just honored to be one of the "good old boys or girls" on an important board. My friend says says you can throw a dart at the Wall Street Journal and the odds are whatever company you hit can be run much more efficiently and much more profitably for shareholders if the company were being run by managers who ran the enterprise for the "owners." If my friend is right, and I believe he is, the private equity folks have enough companies to "clean up" to last a lifetime. The mutual fund industry is primarily engaged in the business of investing in stocks. The private equity industry is primarily engaged in investing in companies. There is an absolute world of difference between the two. Too many investors believe that the private equity crowd is bad for the markets and, like the leveraged buyout crowd, are destined to dry up and blow away. They are just as wrong in that assumption as they are in believing that the majority of boards of directors in this country are primarily serving the interests of their shareholders. There are private equity deals being announced every day. There is a simple meaning for their actions: US stocks are cheap, too cheap. With low interest rates and cash flows in good shape, if you throw a dart at the Wall Street Journal, you are likely going to hit a company that can not only be run more efficiently with a "owner" driven CEO, it can be bought with its own net worth. Private equity is just another way to own companies. My guess is that it is in its infancy and that is good news for the stock markets here and around the world. The surest evidence that this is true is that the government is moving to regulate it and tax it. I'm not going to tell you what my friend has to say about the government and taxes.