Friday, November 07, 2008

Private Equity Dethroned

The rationale behind participating in private equity transactions - MBOs, LBOs, spinoffs, carve outs, etc. - is that the ability of investor/managers to reorganize a company away from the quarterly scrutiny of the capital markets will add enormous value. The ultimate purpose is that competent managers will make an unprofitable company healthy and deliver outsized returns to private investors. This theory is going to be seriously tested by the credit crunch.

Take a look at the latest results from one of the mack daddies of private equity investing, the Blackstone Group:

The Blackstone Group said Thursday that it lost $502.5 million for its third quarter, a sharp reversal from last year as the private equity firm’s investments were buffeted by the market turmoil that swept the world.

I generally agree with Blackstone's contention that mark-to-market rules shouldn't be applied to private equity firms, but the problem here is that Blackstone surrendered its right to call itself a "private" firm when it went IPO last year. Sorry, guys, but if you want access to the capital markets you have to live with transparency and all of its disclosure requirements.

They're not the only private equity firm in trouble. Cerberus is grasping at straws for a way out of its malinvestment in GM and Chrysler:

Cerberus is weighing a plan to distribute its GMAC stake to investors in its private-equity funds, according to the people, who declined to be identified because the deliberations aren't public. The tactic, one of several options under discussion, may enable Detroit-based GMAC to become a bank and get funding from the U.S. Treasury and Federal Reserve without subjecting Cerberus to banking regulations.

Maybe Cerberus learned something from Blackstone's headaches with mark-to-market accounting. Treating GMAC like a bank will make it subject to accounting rules for publicly held companies without exposing the rest of Cerberus' holdings to forced writedowns. Pretty crafty, guys, if you can pull it off.

Private equity ventures are yet another casualty of excessive leverage. Too much liquidity was force-fed into deals that shouldn't have been executed. I intend to eventually engage in private equity transactions via Alfidi Capital LLC, but I've learned my lessons from the problems above. My firm will never go IPO, borrow several multiples of its earnings, or give up control of its holdings in exchange for government assistance. My private deals will be just that: private.