Thursday, February 8, 2007

Whoa, Nellie!

Business.view at (cute use of dots, btw) writes—rather hysterically, in our view—that the "[the] backlash against the private-equity boom is becoming a tad hysterical." As evidence, they cite recent opinion pieces by John Gapper in The Financial Times and Ben Stein in The New York Times.

As is typical of many apologias for our current system of capitalism found in The Economist, there is a lot of apparent even-handedness ("still," "on the other hand"), but at the end of the day what caps it for B.v is that 1) "many private-equity firms are paying over the odds for their acquisitions" and 2) "the shareholders of [the] firm must approve any sale." We shall dispatch each of these arguments in turn.

First, I think few would dispute that all acquirors, private equity and strategic, are paying lots of moolah for their acquisitions nowadays. Money is cheap and plentiful, and most businesses are relatively healthy, so acquisition multiples have been climbing relentlessly. No-one disagrees that the market is swamped with drunken sailors wearing Hermes ties flinging buckets of cash at anyone who has the sense to tack the initials "LLC" to his door. However, it is not obvious that public company shareholders always get enough value for their shares. Pointing out triumphantly that a boat's keel is floating six inches above the high tide mark is not a particularly compelling argument to someone sitting knee deep in water because a surge tide is lapping over the gunwales. The ancillary point—also true—that PE firms are competing vigorously for acquisitions does not by itself guarantee that shareholders are getting full value, either, for no PE firm worth its Park Avenue address competes to pay full value for its purchases. It pays enough to win.

The second argument B.v puts forward—that shareholders can always vote down any deal they do not like—is almost laughable in its naivete. Since when, in this country, do public company shareholders take any meaningful supervisory governance role over their portfolio companies? Even when they do, a shareholder vote is almost exactly like closing the barn door after the horse has escaped: all the important decisions, like which deal, who, and how much, have already been made by management and the Board of Directors. It is a pretty crude and clumsy tool, when all you can do as an owner of a company is vote "yes" or "no." No wonder most shareholders take the money and run.

No, as Mr. Gapper points out, the problem with management-led buyouts is a structural one. Once a senior management team has made the emotional, financial, and often contractual decision to sign up with a particular buyout firm, they become advocates of a deal and, in fact, their particular deal. Management holds all the best inside information and has umpteen ways of encouraging or discouraging their own or other bidding teams from putting forth effective competing offers. The only ones guarding the cookie jar at that point are the independent directors of the Special Committee, who have the unenviable task of jumping into the shark tank covered in sheep's blood wearing a sign saying "Bite me."

I am sure many independent directors at many public companies are in fact independent, even though recent corporate history in this country does give me pause. I am also sure that most of these fine men and women are full of integrity and seek to execute their fiduciary duties as fully as possible, if for no other reason than the watchful circling of the Plaintiff's Bar. But I am also certain that most of these independent directors are hopelessly outgunned in high-pressure negotiations with the deal partners of buyout firms, who buy companies like theirs for a living. And their golf buddy Joe, the Chairman and CEO, who brought them onto XYZ Company's board and got them into Baltusrol, is now on the other side of the table, smoking a 12-inch Cohiba and chatting amiably with some Private Equity Grandee out of New York who eats small children for breakfast. Who would you put your money on?

Of course, as Business.view points out, not all public company buyouts pan out this way. The frenzied auction for Equity Office Properties Trust, in which EOP's Board was able to squeeze another $3 billion out of the bloodless turnips at Blackstone, is a shining example of a buyout done right for shareholders. But guess who drove that bus. Not CEO Richard Kincaid or his senior management team, who may or may not end up salaried partners of Blackstone going forward, but mean, sneaky Chairman Sam Zell, who had approximately one fifth of his pro forma net worth riding on the deal outcome as a shareholder himself (talk about alignment of interest!) and who has been reliably reported to eat Private Equity Grandees for breakfast. Especially after this outcome, I do not think Steve Schwarzman will be inviting Sam onto his advisory board.

Say, there's a thought. Perhaps we can persuade old Sam to drop his bid for the Tribune and become sort of a Lead Independent Director for hire, one we can airlift into boardroom negotiations for public corporations whenever the need arises. You know, sort of like a spine transplant when the CEO and his team jump over to the Dark Side. I'd pay real money to see that.

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