Those of you who read me know my ideas about private equity and how it has become an increasingly efficient way to invest the “big bucks”. I wrote about this in China and Blackstone: bad news for capital markets, good news for private equity.
I have to confess I like the concept of private equity. Although private equity firms probably wouldn’t considering hiring me, I’d hire them to increase efficiency. Their whole business is about efficiency gains: buy some under-performing firm, use your credibility to increase debt to pay the buy-out, make it perform again. If the gains are similar to the costs, the company is yours… *for free*.
Of course I’m exagerating. That’s a simplification, but, for comparing purposes, what happens if you compare their strategy to the diversification strategies undertaken by big companies? We have extra resources, we are not really interested in giving them away to our investors, or owners, so we are going to buy some business out of our core knowledge and know-how to have less risk and at the same time less yields.
Why should anyone do that? Well, managers would say there are synergies to be gained, but, as you know, sometimes those synergies never make it out of the power-point file.
The real reason to do that is that the managers need to keep busy, and need content to present in their next shareholders meeting, probably speaking about another business they don’t know anything about. (Fortunately, neither the shareholders)
Are they paid to do this? Are they suitable to do this? Hell, no!
Not so long ago, they were pretty relaxed and calm because nobody would object anything to that strategy. Even shareholders didn’t see that it was easy to reduce their risk just diversifying investments in different companies instead of diversifying core businesses.
If the investor can diversify by himself, companies shouldn’t try ventures alien to their business.
Then, why were the big companies so unperturbed just doing that? Because they were huge. Or at least too big for hostile takeovers.
And then came KKR with RJR Nabisco (See article about KKR here), and Cerberus with Chrysler (See article about Cerberus here), starting a series that could end with ABN Amro or who knows what. Being huge is not safe anymore.
A new signal emerges from markets. It’s the end of diversification. It’s time to concentrate on your core business. For public companies there’s only one protection strategy for private equity. And it’s no longer to be huge, now you need to be efficient instead.
Barbam propinqui radere, heus, cum videris, praebe lavandos barbulae prudens pilos
(in latin, if you neighbour is being shaven, do get your beard ready)
*Efficiency will save you from private equity*
Got an interesting non core business? Let it go. Otherwise private equity will come for you, and spin it off you.
Inside the non-efficient companies lie a lot of unused resources that justify the gains private equity need as an excuse to assault them. If only those companies could use those same resources for protection…
But that would mean being efficient again. That would mean ruthless reestructuring. That would mean hard and painful decisions. That would mean having to face change, sometimes radical change. That would mean challenging established authority. In short that would mean working more and better.
One last problem about leaning and trimming yourself: why do it yourself when private equity can do it more efficiently than you? (And market seeks efficiency, somehow)