Monday, June 27, 2011

Private Equity Goes Public

A recent Wall Street Journal article spotlighted the growing trend for private equity firms to go public. Included in the group were Apollo Global Management, Blackstone, Och-Ziff, Fortress and, soon, Carlyle Group.

Here's the passage that purports to explain the trend,

"Many of the firms speak of talent they can recruit and retain using shares. Some have said their primary duty remains to investors in their funds, not public shareholders."

Face it' those are lies. The only reason private equity firms go public is, as I wrote in posts regarding Blackstone's transition to having public owners four years ago, is to sell at the top of their valuations, relative to where the private equity firm owners see their firms' near-future valuations.

The real allure of working for a private equity firm is to have one's sizable compensation participate, at least partially, in the firm's own deal funds. To work for a firm unemcumbered by so much of the regulation of publicly-held financial sector firms. And to be part of a shadowy elite in the financial services world. None of that remains when the firm goes public.

In my last Blackstone-related post, I wrote,

"Which goes to prove my contention that you never, ever want to be on the other side of an IPO of any equity-oriented investment bank.

First, they don't sell at a trough. They are smarter than that. If they are selling, why on earth do you want to buy. Their very sale means they think the asset- their firm- is overvalued. In each case here, the founders were correct. If anything, you should consider buying puts on the shares, rather than buying the equities.

Second, these firms are not managed the same way when so much cash is off of the table. Either the founding owners can now take excessive risks with outsiders' money, or they might just take it easier, having realized billions in cash returns. Either way, the prior track records of prudent, steady returns is probably over."

I don't believe any of that has changed.

Despite the Journal's piece suggesting that private equity firms which go public may become more "professionally-managed" and invest more in running their firms, as well as build brand value, I think something else is afoot.
All you have to do is look at the long, 40-year experience of former Wall Street partnerships gone public. Generally, owners cashed in at the top, took excessive risks with new shareholders' money, and took formerly-nimble, lean firms, turned them into slower, overly-manned and -regulated public entities, and diluted their performance.

The public isn't buying into or getting what the former private owners enjoyed.

Further, if private equity firms go public to attract more capital, that means the barriers to entry of the sector are falling, more capital will chase the same amount of deals, and profit margins will fall as risk rises.

Which is pretty much happened with the old Wall Street partnerships. Many went out of business or were acquired. In short, this phase is suggestive of a move of the sector to maturity, not a more profitable era.

Perhaps larger in scale and gross profit dollars, but on lower margins and with higher risks.

As always, investor/buyer beware.

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