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The new masters of the universe
A V Rajwade
 
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June 18, 2007

Private equity keeps making news. Next week will see the first public issue of a private equity firm, Blackstone -- the same firm in which the Chinese had agreed to invest $3 billion for a 10 per cent stake just a few weeks earlier.

The public issue will yield a good paper profit to the Chinese. Karl Marx must be turning in his grave with a communist government investing in "finance capital" which leftists of all hues hate!

From Barbarians at the Gates (the title of a book about how Kohlberg Kravis Roberts, KKR, a private equity fund, took over RJR Nabisco in 1989), private equity fund managers are fast emerging as the new kings of marauding finance capital.

Nothing seems to be beyond their reach -- from drugstores to student loan companies to utilities to airlines. In the first four months of this year alone, KKR has invested in takeover transactions worth $120 billion, more than the combined total of the previous two years.  Blackstone is its closest competitor. A $100 billion deal is probably not too far away.

The sheer scale and confidence of private equity is probably best exemplified by the purchase, by Cerberus, of Chrysler, the troubled US car unit of DaimlerChrysler, the giant German maker of the famed Mercedes Benz cars. Daimler had purchased Chrysler, the third largest car maker in the United States, for $35 billion a few years back.

It is now paying $650 million to Cerberus for taking Chrysler off its hands. It will retain a 19 per cent share in Chrysler, with Cerberus taking control by putting in $7.4 billion of new equity. For Daimler, perhaps the greatest relief was that it will no longer be responsible for the $17.5 billion of unfunded healthcare liabilities to Chrysler employees.

The sheer audacity of the Cerberus takeover is breath-taking. If anybody, Daimler had the "core competence" to make a success of Chrysler; it failed, and now Cerberus hopes to succeed where Daimler could not. Indeed, the way private equity funds are snapping up businesses, generally through leveraged buyouts, they are looking more and more like old style conglomerates: it was the failure of several conglomerates in the US that had made "core competence" a fashionable management slogan.

Broadly speaking, the term private equity comprises all kinds of equity investments, made otherwise than on a stock market and by investors who are not the original promoters. In this sense, private equity includes everything from venture capital to buyouts.

Arguably, several government-sponsored or owned funds, carved out of the country's reserves, are sometimes acting as private equity. Such countries include Norway, other oil exporters, Singapore and so on. Recently, China has announced that a part of its huge hoard of reserves, $1.2 trillion and counting, would be invested in assets other than the risk-free investments in which reserves are traditionally kept.

Private equity funds are typically limited liability partnerships. The fund manager secures commitments to invest from outside parties like institutional investors (banks and insurance companies, university endowments, pension funds) and wealthy individuals, to invest in the fund.

The manager is compensated by way of a 1 or 2 per cent management fee, plus of course, say, 20 or 25 per cent of the profits the fund may make. The objectives of the fund, for instance that it would focus on a particular industry, or on leveraged buyouts, are specified at the time of floatation of the fund. It is the manager's responsibility to scout for investment opportunities and call upon the investors for moneys, as and when they are needed.

Typically, a fund may take a couple of years to get fully or substantially invested. Private equity investors of course need an exit route, generally over a three to five-year time span. The exit may come through divestment in a public issue or sometimes by sale to another private equity or strategic investor.

Several Indian companies' acquisitions abroad have comprised purchases from private equity investors (the latter are quite active in the Indian market also).

If private equity negates the core competence theory, the more successful ones also raise questions about market efficiency.

Most of the leveraged buyouts are done at well above market prices, and the funds often manage to make a lot of money over that. In fact, the record of private equity in buyouts is superior to that of corporate takeovers where, most research suggests, the acquirer company has lost out. Daimler's takeover of Chrysler is a striking example.

Tailpiece: I visited Dubai last week. I travelled on Air India by business class both ways. Haldiram's of Nagpur seems to have become the sole supplier of snacks to Air India -- and no peanuts (let alone cashew nuts) or potato crisps, were available. With due respect to Haldiram's, at least I did not find the snacks tasty. Air India used to have much higher standards in an earlier era. In any case, why the monopoly?


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