Private equity: what's the limit?
Just before Thanksgiving, Blackstone Group bought Sam Zell's Equity Office Properties Trust for $36 billion, setting a record for the largest leveraged buyout ever. link.
Many private equity experts say it will be difficult, although not impossible, to pull off a much larger deal. The reasoning goes like this: The largest funds are typically in the $15 billion range. Fund charters generally limit an investment to 10% of a fund's size. It's been common practice in recent years for private equity groups to collaborate in "clubs" of four five five members. If each member can contribute $1.5 billion, the club can put in a combined total of about $7.5 billion in their own equity. Assuming that the deal includes 20% equity and $80 debt, the upper limit for the size of an LBO ought to $37.5 billion, or the approximate value of Blackstone's Equity Office takeover.
Now, many analysts allow enough wiggle room to allow for the possibility of a $50 billion deal. Private equity funds can tap limited partners such as universities and pension funds for additional equity. The size of their own equity will check will increase as their funds get larger. Blackstone already is raising a $20 billion fund. And debt ratios can be streched.
One senior investment banker says private equity firms can pull off bigger deals than most people think. That banker, who declined to be identified, said a consortium of big private equity firms probably has the wherewithal to buy any but the very largest companies. According to his analysis, the 50 largest companies in the world--the IBMs is too big for an IPO. Its $141 billion market cap is insurmountable. But there already are signs that a $70 billion or $80 billion deal is feasible. The $33 billion LBO of hospital company HCA included only $4.5 billion in equity. Could a group of private equity firms assemble $9 billion or $10 billion in equity and enough debt to fund the takeover of a media company like Time Warner or Viacom, which have marketp caps in the mid-$80 billion range. It's not unthinkable, the banker says.
He won't predict that an LBO of that size is likely this year or next. But he's pretty confident that an LBO record, very possibily in the $50 billion range, will be established in 2007.
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