The Private Equity Effect


As buyout firms hunt for underperforming public companies, many are trying to boost their stocks with asset sales, spin-offs, and restructurings

Private equity firms are on the hunt like never before. With increasing amounts of cash at their disposal, firms like Blackstone Group, Texas Pacific Group, and Thomas H. Lee Partners are chasing more deals and hunting ever-larger prey. So far this year, the value of companies acquired through buyouts has more than doubled to $487.2 billion.

Almost no company is beyond their reach. In February, Texas Pacific, Kohlberg Kravis Roberts, and Goldman Sachs (GS) cut a deal to acquire the Texas utility TXU (TXU) for $45 billion, in the largest buyout ever (see BusinessWeek.com, 2/26/07, "How Green Green-Lighted the TXU Deal").

Now, a growing number of public companies are taking action to stay beyond the grasp of the private equity firms. They're spinning off assets, rethinking their portfolios, and overhauling their balance sheets to keep the buyout barons at bay.

There was a spate of such deals on June 4. Dominion (D) said it would sell its onshore oil-and-gas businesses to Loews (LTR) and XTO Energy (XTO) in two separate deals worth a total of $6.5 billion. General Electric's (GE) real estate arm said it would buy the Canadian operations of Dundee Real Estate Investment Trust. And Reuters (RTRSY) reported that American Express (AXP) had decided to sell its private banking unit.

Private Pressure

The value of spin-offs has increased 14% so far this year, to $56.8 billion, according to the market research firm Dealogic. It's clear evidence that private equity, coupled with powerful shareholder activists, are changing the way all companies do business. "Private equity guys are putting pressure on public companies to become more efficient and boost their share price," says John Altorelli, a partner and mergers-and-acquisitions specialist at law firm Dewey Ballantine. "If those companies don't do it, somebody will do it for them."

The private equity effect looks like it will only grow in the months ahead. With buyout firms raising larger war chests and pressing into new industries, more public companies will feel the heat. "It sure looks like it will pick up this summer," says Robert Profusek, head of the M&A practice at law firm Jones Day. "The trend toward deconsolidation appears to be accelerating."

Not so long ago, investors valued big companies with diverse asset portfolios. Such companies, epitomized by überconglomerate GE, were supposed to ride out the ups and downs of the economy. While one set of businesses was out of favor, another set of businesses would be in favor, ensuring a ready, reliable pace of growth. Now, even GE is selling off major chunks of its business, including its plastics operation in May for nearly $12 billion (see BusinessWeek.com, 5/21/07, "Saudi Firm Buys GE Plastics for $11.6B").

Strength in Numbers

Private equity firms have challenged the approach in part because of their strong returns. Buyout firms are generating profits of 20% to 30% a year, more than twice the returns of the Standard & Poor's 500-stock index in 2006 (see BusinessWeek.com, 3/28/07, "Prospecting for Private Equity Targets"). That gives PE firms the power to buy ho-hum public companies and still make big profits, if they can bring their returns up to those of the firm (see BusinessWeek.com, 4/3/07, "When Bad Stocks Make Good Buyouts").

Private equity firms are fueling the sale of corporate assets in other ways, too. Companies are emerging from leveraged buyouts with debt ratios of six or more times EBITDA (earnings before income, taxes, depreciation, and amortization) (see BusinessWeek.com, 5/29/07, "Private Equity's Big Debt Burden"). That compares with an historic average of about four times EBITDA. Private equity players often sell noncore assets to lower debt ratios and hasten a return on their investment. "And with the rise in stock prices, LBOs are becoming too expensive in many cases," says Profusek. "So private equity buyers are acquiring parts of companies, rather than the entire thing."

Deconsolidation by Market

Asset sales are underway across the corporate map, from media to financial services. They are occurring in the U.S. and in other markets around the globe. Old companies and new companies are under equal pressure to change and perform.

The financial-services industry has seen a flurry of asset sales and restructurings, thanks to a variety of pressures on business. Some lenders have been forced to sell off assets that were damaged in the subprime mortgage meltdown. Lender Fremont General (FMT) is selling its subprime unit. Citigroup said in December, 2006, that it would buy the affordable housing business of Capmark Financial Group.

More asset sales in financial services are likely. Citigroup itself is under tremendous pressure from disgruntled investors to boost its share price with more cost cuts and asset sales. Morgan Stanley (MS) is also under pressure to keep pace with Goldman Sachs. ABN Amro (ABN), which is the focus of a bidding war between Barclays (BCS) and a group led by Royal Bank of Scotland, is considering the sale of its Chicago-based LaSalle Bank business.

A wave of deconsolidation has been sweeping through the restaurant business, too. During the last two years, Wendy's (WEN) has spun off its Tim Hortons (THI) doughnut business to the public, and Pernod Ricard sold its Dunkin' Donuts business to a group of private investors for $2.4 billion (see BusinessWeek.com, 12/20/05, "Of Donuts, Debt, and Deals").

During the coming months, the media business could be an especially fertile group for asset sales and spin-offs. An increasing number of private equity firms have become active in the media business, ratcheting up the pressure on the remaining public companies. Sam Zell's buyout of the Tribune (TRB) company will lead to the spin-off of at least some assets, such as Tribune's Chicago Cubs baseball franchise. General Electric has been under pressure from some investors to sell off its NBC network. And there's regular speculation that media giant Time Warner (TWX) could wind up in a massive breakup that separates its cable TV business, its filmed entertainment unit, its AOL Internet unit, and its publishing empire.

Some Strongholds Remain

The movement toward deconsolidation isn't all-encompassing. There are more than a few companies powerful enough to resist the trend.

Google (GOOG), in the words of one investor who declined to be identified, is aggregating power every day. Far from selling off divisions or business, it is buying its way into one market after another. And Microsoft (MSFT) remains a buyer as well. In May it paid $6 billion for online advertising giant aQuantive (AQNT), pushing its way deeper into a new business (see BusinessWeek.com, 5/18/07, "Microsoft's Big Online Ad Buy").

For every Microsoft or Google, there are countless other companies that find it more difficult to justify their role as public companies. The irony: To remain in the public domain, they must think more and more like private equity firms.


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