A Private Equity Bubble?

The Saturday/Sunday edition of the Wall Street Journal is typically rather lightweight in content. My partner is of the opinion that much of the edition is filler that wouldn't make the weekday paper.

However, this weekend's "Breaking Views/Insights on Investing" discussed the recent Blackstone private takeover of Equity Office Properties from the perspective of bubble investing.

I admit to having forgotten how the Federated/Campeau fiasco drove then-independent First Boston into the arms of Credit Suisse. The American investment bank had funded Campeau's takeover of Federated stores with a bridge loan which it held, anticipating syndicating the loan among other institutions. First Boston proved unable to do this, and, thus, took the loss as Federated went bankrupt in 1990.

Sixteen years is a long time. Now, Blackstone Group is paying $36B in the largest private equity takeover of all time. According to the WSJ piece, Goldman Sachs and Bank of America are risking some $3.5B of their shareholder's capital by holding a block of the deals equity.

I'm not familiar with the economics of the underlying transaction. Perhaps Blackstone feels that commercial property has bottomed, and now is the time to buy. Or perhaps it just feels that the outlook for commercial property rents and appreciation are more attractive than the market does. Either way, it's a very large move.

Leaving two publicly-held banks, Goldman and BofA, with 10% of the deal's financing of which to dispose, seems peculiarly risky. This is the sort of thing, as the Journal article reminds us, that goes bad in an instant, with no way to recoup the losses. The reason the authors give for this funding move is simply that the fee income from funding this deal is enormous.

That this is an attractive alternative for the two firms suggests the extent to which they now feel they must take capital risks in order to generate income.

And, of course, it probably won't take much of a shadow of uncertainty to cloud the deal's fortunes such that the 'equity block' that these two companies hold declines by far more than the amount of the fees they're booking.

As always, time will tell.......