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So Private Equity Isn’t Evil After All . . . .

September 15th, 2009 | 1 Comment | Posted in Management, Private Equity, Venture Capital

Yesterday, Ernst & Young Europe released a report on the exit performance of European private equity investments.  “Challenges in a New World: How do private equity investors create value: A study of 2008 European exits” provides a fact-based assessment of European private equity investments.  This assessment stands in stark contrast to the infamous remarks of Germany’s Franz Müntefering.  As noted in a piece by Time on the 2005 German election, Müntefering “In his most cited remarks, compared private equity groups and short-term investors like hedge funds to “swarms of locusts” that fall on companies, devour all they can, and then move on. “Some financial investors don’t waste any thoughts on the people whose jobs they destroy”.  In America, the Service Employees International Union (SEIU) has opined for a long time on the evils of private equity.  A recent quote from an email blast to their membership regarding the FDIC’s recent regulations on private equity bank buyouts sums it up nicely:

“From: Stephen Lerner
Subject: Financial wolves

Dear Friend,

The wolves are at the door.

Some of the most secretive, unregulated financial firms are in the market to buy failed banks. Problem is, they want to do it with taxpayers’ money – and keep most of the profits for themselves.

These big firms – called private equity firms – build their whole reputation on making large profits in short periods of time by taking big risks. Worse yet, they can exploit weak regulations to get it done.

 Now these financial wolves want to bring their brand of risk-taking to the same banking industry whose own wild risk-taking helped collapse the economy in the first place.”

Overcoming such perceptions is tough.  While the Private Equity Council did a good job trying to refute the SEIU claims, the EY report brings some sharp facts into focus.  Here are a few salient quotes from the EY report:

“The most significant finding of our research is that, in aggregate, large businesses across Europe achieved impressive growth and performance improvement under PE ownership. Our findings show average per annum growth of 15% in profits, 5% in employment, and 9% in productivity from the time of acquisition to exit. “

“In addition, in each of the key growth metrics of profits, productivity and valuation multiple, PE outperforms its public counterparts (see figure 3 on page 6). Our results also show that PE-owned businesses grew total employment at a faster rate than their corporate peers. However, it should be”

“Our 2008 findings also show that PE has demonstrated a willingness to hold onto and fix the troubled investments in its portfolio. Indeed, the average hold period of seven years for troubled assets was approximately twice as long as that for all other investments.”

One of the most popular myths about private equity is that the bulk of their returns are generated through financial engineering.  As the EY study demonstrates, the source of profit and valuation growth is primarily driven by organic revenue growth and then add-on acquisitions.  Cost reduction, while significant, represented the minority of profit and valuation improvement. 

 EY Study 1

While the EY report does provide a positive assessment of European private equity investment performance it is important to note that in the U.S. private equity has a bit more of a mixed performance.  As noted in the Wall Street Journal’s Private Equity Beat there have been numerous private equity backed firms that filed for bankruptcy in 2009.  In addition to the high profile Cerberus backed Chrysler bankruptcy, 22 buyout backed firms went bankrupt in the first quarter of 2009, as shown in the following table from LBO Dow Jones LBO Wire:

EY Study 2

So while the reality of private equity being evil may have been refuted, there is certainly a long way to go before private equity will ever be considered angels.  In the course of discussions regarding the re-regulation of the financnial services industry, Treasury SecretaryPerhaps Tim Geithner has stated that private  equity and venture capital represent a system risk to the global economy.  Perhaps as private equity begins to deploy the hundreds of billions of dollars of univested capital that they have and Americans begin to see the benefits of these investments, public perception will begin to shift somewhat into a more positive direction.

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