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Current Events and Commentary

Private Equity Firms Are The New 900 Pound Gorilla in Corporate Finance

January 2007
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Private equity firms boomed in 2006, raising a staggering $215.4 billion according to statistics tallied by the Dow Jones Equity Analyst.  This beat the prior record set in 2000 by 22 percent, and was 33 percent higher than what occurred in 2005.

322 funds raised the record 2006 amount.  But, only eight firms comprised around a third of the $215.4 billion.  Bain Capital, Blackstone Group, First Reserve, Kohlberg Kravis Roberts & Co., and Texas Pacific Group raised the largest amounts.

The private equity firms quickly employed this war chest to purchase companies.  According to statistics compiled by Fortune magazine, private equity firms purchased 1,010 companies in 2006, compared to only 324 companies acquired by private equity firms in 2001.  The largest 2006 acquisitions, each of which exceeded $10 billion of private money, include Quantas Airlines, HCA, Hertz, Clear Channel Communications, Equity Office Properties, Harrah’s Entertainment, Freescale Semiconductor, Kinder Morgan, U.S. Trust, Albertson’s, and Biomet.

As a point of reference, 2006 was not a bad year for initial public offerings (IPOs). According to statistics compiled by Renaissance Capital, 2006 had 198 IPOs that totaled $43 billion.  This was the largest IPO amount raised in six years.  The largest IPOs were MasterCard, at $2.4 billion, Spirit AeroSystems at $1.4 billion, and Douglas Emmett at $1.4 billion.  All of these IPO statistics are quite small compared to the total and individual private merger deals listed above.

The following factors are driving these large private equity deals:

  1. Institutional investors, such as pension funds, endowments, and insurance companies, are seeking to boost returns over what they believe they can achieve with public equity investments.

  2. There is relatively inexpensive debt in plentiful amounts.  This is important because the private equity deals often use considerably more leverage than their public company counterparts.

  3. It is difficult to be a public company.  This occurs because of increased regulation from laws such as Sarbanes-Oxley, as well as continuing risk of shareholder litigation when problems occur.

The large amount of private capital attempting to be employed in merger deals is causing the private equity funds to lower their yield expectations.  Prior return expectations exceeded 20 percent, but return expectations are now in the mid-teens.  Returns in the mid-teens are not that exceptional in light of the increased risks these deals have because of their larger debt amounts.

 

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