Private Equity Firms and Large Company Acquisitions

Richard Friedman’s key factors for Private Equity funds targeting large companies- financing, downturn lag effects and compensation limits on management, listed here
http://randomjunkyramblings.blogspot.com/2009/03/6-private-equity-firms-and-large.html

- lead to a host of follow up questions.

Are the public capital markets more imperfect than perfect at corporate governance? In more cases than not, have capital markets been reduced to purely reflecting the underperformer reality of a large company as opposed to packing the bite that enforces change? Fragmented ownership is a factor. But is that it? There are numerous cases of an activist investors that have not met their primary objectives (I am not talking about activist investors whose primary objective is greenmail).

If we look at Friedman’s 3 points, and buy the fact that no team can consistently beat economic headwinds to provide massively outperforming returns, would you call private equity firms spectacular market timers? Gives you a simple screen- find a lag effect, and find a management team that’s already furiously at work to beat it, incentivize it to keep the boat steady, and voila! outperformer returns!

Consistent market timing? Really? A simple screen provides outperformer returns? Consistently?

Now, running a large enterprise that is suffering lag effects of a downturn takes some skill. At the simplest level, the private equity investor can certainly simulate an activist investor and provide senior management the backing it needs to rechannel energies from quarter to quarter window dressing into initiative that dovetail with the exit time frame. The private equity takeover can function as the step change that galvanizes the organization into focusing, even functioning as a hedgehog focused on a target.

Even these “operational improvements” count on:
existing management’s ability to direct, or shake up, existing relationships, or,
the investor’s ability to bring in people that can achieve the investor’s objectives.

Contingent upon incentives working, once the deal is struck, execution patterns and outcomes similar to Post Merger Integration efforts should dominate.

Stepping back, what are the patterns and markers that a private equity investor can use to manipulate the trade offs across financing, directed human capital (read operational improvements), and macroeconomic conditions to achieve outperformer returns?

The question’s underlying axiom is obvious; it is possible, with some consistency, to provider outperformer returns. You now also have a rudimentary structure (dare I say a quant model? :-)) to value the impact of these three components on final returns.

What do you think?

The Usual Disclaimer: This is purely a knowledge sharing resource and I have been careful to protect panelist interests. Ethically, context is everything, and I will gladly retract anything that affects the parties mentioned. Call this my mini OpenCourseWare, if you will, where Open signifies life experiences.