A recent Financial Times article on private equity woes in an era of high interest rates contains many amusingly coded admissions against interest. Before we get to the industry’s new clever gimmick, that of dumping companies on new greater fools, here their employees, we’ll look at some of the discussion of oh how hard it is to be private equity kingpin when the Fed no longer has your back.

The opening whinge is the canard that private equity funds can’t sell the companies they own:

Higher interest rates and a still sluggish new listings markets have made it harder to sell holdings and return cash to investors. That in turn has made it more difficult to raise new funds because pension funds, endowments and family offices have less money to allocate and a growing array of other options.

The people who run these funds and their investors are presumably investment literate. The first rule of finance is that every problem can be solved by price. The problem here is not that these companies cannot be sold, but that their private equity masters don’t like the prices they would fetch.

The related issue, which may not be obvious to many readers, is that the major private equity investors like public pension funds, have historically expected and had private equity funds succeed in returning funds to them fairly promptly, with the historical duration only about 4-5 years between the time it takes to get the money invested and the private equity firm incentive to sell a decent chunk of its purchases by the 4-5 year mark to facilitate raising new funds. These investors need their money to be at work. So when they receive distributions, they need to re-invest, and since nearly all have high and rising private equity allocations, the funds need in large measure to go back into private equity funds.

Money tied up in older deals is bad for industry economics. Private equity fund managers get higher management fees in the early years of their funds to reward them for all that work of buying companies. They also collect hefty transaction fees for baby-sitting top Wall Street firms to execute the transactions, and typically funding fees too for lining up the debt. Hence the enthusiasm for a new way to unload, or at least partly unload, those companies no one will buy at the price their private equity overlords want to realize. Again from the article:

One way to tell that the squeeze is starting to bite is the recent announcement by Blackstone, the biggest and best-known PE firm, that it has launched a “shared ownership initiative” to give workers at its portfolio companies an equity stake. The programme will start at Copeland, which Blackstone bought for $14bn last year. When the climate control group is ultimately sold, its 18,000 employees will receive payouts tied to the PE firm’s profits from the deal….

Ownership Works has helped organise employee share schemes worth nearly $400mn at 88 companies and is targeting $20bn within a decade.

For private equity firms struggling to woo new investors, these plans have multiple attractions. First, they allow PE sponsors to argue that they are helping address social inequality…

Such claims are likely to resonate with investors who are concerned about PE’s role in directing most of the profits from productivity gains to investors rather than workers over the past couple of decades.

Ahem. For those who have followed the tale of increasing wealth at the top, the way to share the benefits of productivity gains with workers is via higher wages, not by giving them less pay than they should get and giving them equity or equity chits at a valuation over the fair market value of the business.

Admittedly, employee ownership can be very motivating and productive when employees really do own the company, as opposed to being along for the ride, as the are here. But even then, advocated of employee stock ownership programs would warn that they could represent a danger to the financial health of the employee-investors. They are already heavily exposed to the fate of the company by virtue of working there. If it has a disaster, like an explosion at a key operation, its staffers could suffer big pay cuts or even job losses. Having some or a lot of their net worth tied up in the company increases their exposure.

The article then turns to a discussion of how private equity firms are not adapting well to leaner living in the current high interest rate environment:

Higher interest rates have fundamentally changed the game for private equity firms, forcing a rethink of how they do business. Between 2010 and 2021, borrowing accounted for half of all of PE’s performance, according to consultants StepStone….

With less leverage, private equity firms must find other ways to deliver strong returns, even as investors demand better results because the comparable risk-free rate is so much higher. “Going forward we have to do things differently,” says McKinsey senior partner Amit Garg. “The question is how.”

The obvious path to lasting profits is through operational changes that increase revenue, cut costs or both. PE firms have always claimed to do this, but leverage has made some of them less diligent than they could be.

This would be laughable except for the fact that private equity has done so much harm by pretending to have a better management mousetrap but for the most part simply being clever about looting companies while not driving too many into the ditch.

I anticipate that some in the peanut gallery will argue, as we have, that private equity does appear to deliver improved operating results with smaller deal sized companies, which they also typically buy with less debt that big acquisitions. However, insiders have pointed out that this does not necessarily mean that the private equity tender ministration resulted in good performance. Rather, they contend that some private equity buyers are good at recognizing “growthy” companies, well positioned players in sectors set to out-perform, and buying them at good prices.

Consider this section just a short while later in the article:

The tried and true methods involve better management. Some PE firms focus on new appointments on a newly purchased portfolio company’s board and management team. Others maintain a staff of full-time in-house consultants who provide services to multiple companies. A third way is to recruit a roster of veteran executives to advise company leaders.

At Goldman Sachs’s private equity arm, its “value accelerator” experts offer advice on everything from picking the right headhunters and consultants to upgrading IT platforms and redesigning management processes.

Help me. These “tried and true methods” have been around for decades yet the story effectively admits they are not delivering the needed returns. The author either does not know or does not admit that those “in house consultants” like KKR Capstone are another mechanism for pulling fees out of the private equity firm. Those services are billed to the portfolio company and the consulting firm/accelerator is another profit center in the private equity firm empire.

It was gratifying to see that most comment on the article were critical of private equity. This is a big departure from a few years ago, when skeptics (including Financial Times journalists) would be depicted as jealous haters. Some choice examples:

AKA alias
It is galling that the same institutional investors bleating about ESG, are all in on private equity, notwithstanding its dismal record of wrecking the long-term prospects of firms through high leverage and one-sided management arrangements, increasing market concentration in the U.S. health sector and elsewhere, reducing service quality to the elderly in nursing homes and low-income tenants, and other vulnerable and less well-off segments of society, mistreating their workforce, and increasing wealth and income inequality, in part through special tax breaks gained and maintained by intense “lobbying”, otherwise known as the corruption of the political process.

Despite this record, sanctimonious institutions seeking to “do good while doing well” through ESG devote massive amounts of their portfolios to investments that have a dismal impact on society, undermine good and transparent corporate governance, and contribute to the corruption of national governments.

Thomas Rainsborough
The PE industry has a small group of intractable problems .

They are massively over allocated , the asset owners who have done this are performance chasers from the zero rates era who will get the returns that performance chasers usually get. Also they are now too big for their exit markets , interest rates have normalised and returns to leverage which is what PE is , are dropping . Passive investing has reduced public market active cash flow so IPO markets are not rebounding and PE is seen as a terrible seller given their track record of listing duds . Actual real companies with shareholders don’t like buying from them because they are seen as poor owners who suck out future value. PE holding values based on listed comps are a chimera. So they play pass the parcel between themselves and a few colossal LPs. That’s what’s happening.

Great, so they can’t even sell the cr!p now and so they off load it to employees, no doubt in lieu of salary…

Perhaps employees’ families can eat the shares they are given?

It’s strangely reminiscent of the collapse of the Soviet Union, where workers were given the goods from the factories they worked at, rather than cash to buy food. So workers then had to sell the wares they produced on the street in order to feed themselves.

Shawn Corey Carter
The ‘retailisation’ of PE, allowing mom+pops to be finally let into the party through accessible funds plus through IPOs of PE houses (sorry, I mean “Asset Managers”) is surely a strong sign that things will come crashing down with joe public being the last one holding the bag after everyone else has long disappeared with their (our) money.

Of course smalltime investors will be burnt, but so will the careers of the hundreds of thousands that are part of the machine as a wage slave, but not really benefitting from the machine.

One reader expressed doubts that any buyer would be interested in purchasing a company with significant employee ownership. The reply:

I work at a PE backed company with one of these schemes and you’ll be pleased to hear it gives us literally zero control over anything.

So one upside of the Fed’s bloodymindness about inflation is that it is not well-positioned to control is collateral damage to private equity. But the industry went through a drying-out period after the leveraged buyout crisis of the late 1980s (fortunately for them, overshadowed by the S&L crisis) and came back. So even if we can hope the industry gets cut down to size, like kudzu, it is also likely, like lamprey eels, to come back with a vengeance.

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