|
What is Private Equity Investment?
By J.B. Bird
Since 1991, the private equity market has undergone massive growth, raising record levels of capital each year over the last decade. The sector hit a lull at the end of 2000, partly to catch its breath, but private equity continues to play a major role in the economy, and promises to be a major factor in global expansion over the next quarter century.
So, what is private equity? Outside of the investment world, few people can describe it with confidence. Thanks to the Internet, once-arcane venture capital terms like “angel investor” are now known to the masses, but non-venture private equity remains a mystery to most.
The phrase itself has only been in common use since about 1990. By then, most leveraged buyout firms – LBOs – had revised their business plans from the “buy and bust” tactics made famous by Michael Millken to the “buy and build” strategies now common among top firms like Kohlberg, Kravis & Roberts, Forstmann Little & Co, and Hicks, Muse, Tate & Furst Incorporated. The new approach was the polar opposite of the 1980s-style corporate breakup. Understandably, the industry looked for a new name – something that wouldn’t remind so many people of Michael Douglass’ famous speech in the movie “Wall Street.”
The major players in non-venture private equity still specialize in LBOs and MBOs (managed buyouts). In contrast to the 1980s, however, they rely far less on debt to make their deals, and far more on equity.
|
 |
||||||||||||||||||||||||||
As Jack Furst, MBA 84, principal and partner of Hicks, Muse, Tate & Furst, explains it, in the 1980s, an LBO might have financed a typical corporate takeover using only 10 percent equity. The rest of the money would come from leverage – debt borrowed against the acquired company’s assets. These deals could lead to spectacular profits, but also spectacular problems.
Today’s buyout firms face a market defined by higher corporate valuations and tighter lending restrictions. Buyout firms can still use leverage to make acquisitions, but with less leeway they must balance a delicate equation of debt, equity, and market factors.
“That is the art of our job,” says Furst.
Firms try to maximize the equation by adding value to the companies they acquire. They do this through an array of strategies such as strengthening management, adding complementary companies, or “rolling up” companies and consolidating fragmented sectors.
Thomas O. Hicks, BBA 69, helped pioneer the value-adding approach in 1988 when his former firm, Hicks & Haas, bought Dr Pepper from Forstmann Little. Rather than break up the company and sell it for parts, Hicks & Haas rebuilt the beverage giant. Within four years, investors who cashed in earned 17 times their initial investment, and those who held on until the 1995 sale to Cadbury Schweppes made substantially more than that.
Hicks, with the help of brother Steve Hicks, scored again in the late 90s with one of the most successful deals in the history of private equity investing, a breathtaking consolidation of radio stations, that ultimately resulted in AMFM Inc., the world’s largest out-of-home media company.
Furst says the firm has succeeded by working most often in the sectors it knows well—media, manufacturing, and food. “We like to buy a good platform company in one of these sectors and then use our capital to play the role of consolidator to add scale, size, and efficiency,” he says.
In that process, HMTF often takes a business global. “We think size matters,” says Furst. “Global reach and capa-bilities matter.”
Each of the leading private equity firms follows its own philosophy. HMTF generally looks to acquire companies that fit its criteria for classic “buy and build” deals. “We like businesses that are stable, predictable, with good gross margins and operating margins,” says Furst, “recession-resistant, not subject to foreign competition, and with reasonable capital expenditures.”
HMTF’s recent sale of two European champagne houses exemplifies the success of its approach. The deal also reveals some of the finer points of the business. In December, Britain’s Allied Domecq plc agreed to buy the champagne houses for 575 million euros ($506 million). Just a year and a half earlier, HMTF had purchased them for 294 million euros, 108 million of which was equity. By improving internal operations, HMTF was able to pay down 60 million euros of the original debt. As a result, they pocketed 450 million euros on the sale-over four times the original investment. Not a bad deal for a bear market year.
For information on specific programs at the McCombs School, consult our contacts page. For media information, contact the Communications Director by phone at 512-471-3314 or by email at CommunicationsDirector@mccombs.utexas.edu.
