Private Equity & Home Depot

Earlier this week, on Wednesday, the Wall Street Journal published an interview with Henry Kravis.

I've written posts about private equity before, here, here, and here. Rather than restate all my thinking and points, you may read them there. Suffice to say, the last six months have not changed my findings regarding this topic.

Now, however, the media is all abuzz about Bob Nardelli, a reputed "operations guy," coming back for Home Depot as the CEO of a buyout group. Was Home Depot simply under leveraged? Would financial engineering have done the job? Certainly, one alternative was simply to dividend back to shareholders the cash that wasn't earning adequate returns at the firm.

What if all the mismanaged companies go private. What if all the good managers go private to run companies more simply? Would we not expect, if this happens, to see S&P average returns fall, as companies with promise leave the index? Or would they rise, because most private equity targets are actually performing below average. That's why they are targets.


Doesn't private equity get its big payday by taking these companies public again? So, isn't this private equity shift the on-shore effect of SarbOx, similar to the fewer IPOs on the American exchanges?

Is it not a sort of return to the 1890-1930s model of corporate chieftains who knew their boards, actually knew how to run companies? A few, wealthy, proficient owners who were largely unfettered by distractions like large numbers of small-scale shareholders? Then, when the juice is squeezed out of the company, the private equity groups will return their prize to the market.......at a premium, of course, to the price at which they took it private.

Let's suppose this does accelerate. Maybe that is the only way corporate boards will wake up and demand better performance, for appropriate compensation, from sitting CEOs. Might not CEOs, a la my post citing the example of VNU, demand higher buyout prices from the private equity groups, as they realize the 2x multiples the latter are reaping?

It should , in time, be self-correcting, should it not? Perhaps a new type of employee/group will arise: the "rental CEO & Co." Imagine a capable, smallish group of corporate troubleshooters willing to 'fix' a troubled company, letting shareholders remain in possession. Suppose they only ask for $20-40MM in fixed compensation for a 2-3 year period- enough to cover their operating risk. Then, they could agree to a fairly high valuation target which, if achieved, would compensate them lavishly, but still for far less opportunity cost than if shareholders had sold out to a private equity group at, effectively, the bottom.

In time, perhaps shareholders will demand that boards get the same performance out of their assets as private equity groups expect to realize after their overhaul of the same assets.

As for Nardelli, I'm not so sure, as I've read more pieces about his management style, that he's really going to fit into the collegial, results-oriented world of private equity. Many media pundits allege that Bob 'got the job done' at Home Depot, but simply failed to be recognized for it. I disagree. By several "operating" measures, such as sales and NIAT growth, he lagged his major competitor, Lowes. Plus, somebody has to be responsible for total return. Perhaps senior functional executives may be measured according to internal financials, or market share goals, but the CEO is paid lavishly to consistently earn superior total returns for the firm's investors. All else is superfluous.