Refilling the glass

Private equity firms are discovering that a glass half full is far from satisfying.

With financing of large leveraged buyouts practically impossible, private equity firms have been increasingly driven into buying minority stakes in both public and private companies as they seek to invest the money given to them by investors.

The problem is that a lot of those investments have lost value and as minority stakeholders, the buyout firms have less power to force a turnaround.

And even worse, the problems are embarrassingly there for all to see, which is a big change for a business that was built on taking companies private and dramatically re-engineering them out of the public gaze.

Shares of Washington Mutual are down about 56 percent from the price buyout giant Texas Pacific Group invested in April; bond insurer MBIA Inc is 84 percent lower than when Warburg Pincus invested in December and Deutsche Telekom shares have lost 22 percent in value since Blackstone Group invested in April 2006.

Despite this, some bankers and investors expect the trend for PIPEs - private investment in public equity - to continue, or even increase.

"We'd expect more of them - explained partly by a combination of large funds and scarce credit - because without ready leverage it is hard to complete LBOs," says Stephen Moseley, president of private equity advisory business StepStone Group LLC.

Private equity firms invested $4 billion buying minority stakes in publicly traded companies in the first half of this year, according to research firm Dealogic - nearly three times the amount the previous year and seven times the amount spent in 2005.

A falling share price doesn't necessarily mean such investments are bad, bankers are quick to point out. Buyout firms hold for the long term and may have years to work out when to sell those positions.

But given their traditional way of operating out of the limelight with a long-term strategy, it can be tough to wake up every day and see an investment sink.

In the short term, share slides can lead to difficult public announcements at earnings time or lengthy explanations to limited partners - the pension fund managers and other powerful investors who put money into buyout funds.

Blackstone in May said its corporate private equity unit reported negative first-quarter revenues, hit by the fall in Deutsche Telekom's share price.

"We've occasionally taken minority stakes," Blackstone's CEO Stephen Schwarzman said in February last year. "Minority interests are harder to make money on than buyouts. It's not our dream."

Indeed, UK buyout firm Terra Firma's boss Guy Hands has publicly attacked a strategy of buying large stakes in public companies.

"That can absorb a lot of capital raised but it's difficult to see how this is the mission of private equity firms," he said at a conference in June.

And the pain isn't just being felt by the buyout investors.

Some sovereign wealth funds that invested in banks and even private equity firms themselves have seen their investments slide. Shares of Blackstone are about 45 percent lower than their $31-a-share initial public offering price last June.

Will patience pay?

Investors pay stiff fees to invest in private equity funds and for that, they expect superior returns, typically generated from the highly specialized business of taking control of a company through a leveraged buyout, turning it around and then selling or floating it.

Buying minority stakes has the major disadvantage that the stakeholder has little control over the company's strategy, which may be more about pleasing shareholders from quarter-to-quarter than in building value over the long run.

Also the argument some investors can make is they could just as easily buy a publicly listed stake themselves and save the fee they would pay private equity firms for investing their money.

But in this drought, it isn't so easy to find opportunities for buyout firms under pressure to invest cash.

And minority investments have some benefits, bankers say.

One advantage is an investment could give the buyout firm a leg up to a majority stake at some point in the future when financing is easier.

That isn't likely the case for many of the investments in financial institutions, however, where a controlling stake in a bank or thrift brings with it regulatory oversight, capital requirements and restrictions on the nature and scope of businesses activities.

Buyout investors can push for other advantages like a seat on the board or perhaps an ability to get some kind of discount if another investor buys in at a lower price.

"We hope PIPEs don't become the bread-and-butter of the private equity industry," says Moseley. "But I think acquiring a significant and influential minority position in a company ... can make a lot of sense and sometimes it can make more sense than leveraging up a company and paying a premium for control."

Agencies

(China Daily 08/04/2008 page11)