Saturday, March 17, 2007

Crooked Timber

Rick: How can you close me up? On what grounds?
Captain Renault: I'm shocked, shocked to find that gambling is going on in here!
[a croupier hands Renault a pile of money]
Croupier: Your winnings, sir.
Captain Renault: [sotto voce] Oh, thank you very much.
Captain Renault: Everybody out at once!

Free exchange at is confused. Poor FE. (S)he writes:

"BLACKSTONE in advanced IPO talks" says the FT this morning (requires subscription), and now I really am confused. Isn't the whole point of private equity supposedly that you can run a company more profitably and efficiently as a private corporation than as a public one? That in the private world you escape the short-termism, the compliance overhead, the social responsiblity that dogs the publicly listed? And here is a top private equity firm that wants to go public: who's fooling who?

Well, FE, I hate to break it to you, but I would reply that it is Private Equity (Blackstone, proxy) which has fooled you (proxy for similarly befuddled media and the Great Unwashed). Take heart, though. Your lament, while refreshingly candid (or is it outraged?), is being echoed in various forms and fashions across the mainstream media this morning.

While few others I have read this morning seem to be channeling Claude Rains' Captain Renault in Casablanca (see above) quite as forcefully as FE, almost every reporter out there is calling attention to the same apparent disconnect between word and deed.

From The New York Times:

A public offering by Blackstone would be a remarkable about-face for an industry that has long extolled the virtues of being private. Executives in private equity have criticized the public markets for being overly regulated and shareholders for focusing too much on short-term earnings.

And The Wall Street Journal:

There would be plenty of irony in a Blackstone public offering. [Co-founder] Mr. Schwarzman has for years evangelized against the failings of public-market ownership to companies he hoped to acquire. In a series of recent public appearances, he has called public stockholding "a broken system" and criticized the 2002 Sarbanes-Oxley corporate-accountability law as having "taken a lot of the entrepreneurial zeal out of a lot of corporate managers." Quarterly earnings reports for public companies, he has said, create a "tyranny."

Now, it seems, Mr. Schwarzman and his fellow PE plutocrats want to exchange a smidgen of their entrepreneurial zeal and a dollop of freedom from tyranny for a few billion of the folding. Hmmm. "Out of the crooked timber of humanity no straight thing was ever made."

Well, the irony is certainly thick enough to cut with a proxy statement, but I might respond to FE and its brethren in the punditocracy by positing a slightly different spin on the situation.

Blackstone and its fellow Star Chamber members in the financial sponsor community have never disliked the public equity markets. In fact, they have always been quite fond of them, since they have been one of the principal sources of their enviable profits and gluttonous personal wealth. After all, if you can't get some knuckleheaded public corporation or desperate fellow PE firm to buy your portfolio company when you are ready to sell, you have no choice but to slap lipstick on the pig and trot it back out to the public equity trough for an IPO hootenany. And there have been periods in this writer's memory when portfolio exits through initial public offerings were private equity's preferred route. Heck, it would not take the fact checkers at The Economist, the NYT, and the WSJ too long to figure out that PE firms have been happily dressing up their darlings for a return trip to the public markets all along. Hertz, anyone?

And this affection is not, as the cynics among us might suggest, simply limited to a seller's fondness for the Greater Fool. In almost every instance of a portfolio exit through an IPO, the PE sponsor is required to hold a substantial portion of its equity stake in the company for a significant period after the initial offering, during which time it remains exposed to all the risks attendant on concentrated stakeholdings in publicly traded companies. In those instances, the private equity partners remain substantial shareholders and members of the Board, where they can presumably observe firsthand the gradual erosion of their handpicked managers' entrepreneurial zeal and the stealthy return of SarbOx sclerosis.

For proof that this experience does not unduly traumatize those tender PE souls who witness it, or reduce their appetite for buying public companies which have suffered under such duress, one need only look to the numerous examples of repeat buyouts of the same company, often by the same PE firm, after it has made repeated roundtrips to the public equity markets. Furthermore, financial sponsors have always known that they would not be in business if certain kinds of company—especially those in need of some form of strategic, operational, or financial restructuring—were not roundly despised and undervalued by public shareholders.

You see, FE, you simply have not been paying attention. Financial sponsors have always looked to the public equity markets as both a source of buyout deals and a destination for their portfolio companies once they have fixed them up. PE firms are opportunists, in the clearest and best sense allowed by capitalism: they exploit the opportunity inherent in the particular situation at hand. If they want to buy a juicy public company which has a say in whether it gets bought or not, of course they will excoriate the public markets' failure to appreciate the company's true value and fulminate against the infamous restrictions being public imposes on the company's managers, who would otherwise be worldbeaters. If, on the other hand, they want to sell a portfolio company to realize their 20% carried interest in the value they have created with their LPs' money, and there are no strategic buyers at hand—or the value offered by an IPO is greater even though the PE firm will have to wait to realize it all—they will call up the investment bankers forthwith for the IPO beauty parade.

Finally, let's be clear exactly what is (proposed to be) going public here. An IPO of Blackstone is not an IPO of one or more of their portfolio companies, but rather an IPO of the investment management company itself. Like the recent moonshot IPO of hedge fund manager Fortress Investment Group, buyers of a potential Blackstone IPO will get a share in the company which generates monster fees for buying and selling portfolio companies (plus some other fund management and advisory business doodads). You, oh would-be part-owner of Blackstone, Inc., will get a little piece of the same business that Steve Schwarzman and his partners have been pulling gazillions out of for the past 20+ years. Appetizing, huh?

There's only one little nagging worry. Up until now PE firms have been remarkably consistent about one thing: they should remain private. (Many of the biggest did not create public websites until recently, natch.) One can see their point. If what they do is focus intently on dramatic strategic, operational, and financial transformations of a series of diverse companies over a period of many years—where success, if it comes, cannot be known for sure until the company is sold or brought back to market 3 to 10 years later—then why oh why do they want or need ill-informed public shareholders kibitzing from the sidelines? Or whining about how many dead presidents Steve S. and his henchmen are skimming from the till? Other than money—a noble objective; don't get me wrong—what are the owners of Blackstone getting out of this?

Perhaps at this point it would be worth reviewing the two primary reasons why any private company contemplates going public. One is that the company needs capital, and for whatever reason public equity is the best source of that capital. The other is that the management and owners of the company think the public equity markets will overvalue the company's shares, and they want to sell while the price is high.

Whaddya think? Does Blackstone need the money?

© 2007 The Epicurean Dealmaker. All rights reserved.