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.

Interesting Times and Investing in Large Cap Companies- Part 1

Is equity investing in large cap companies during uncertain times similar to venture capital investing if the 3 conditions below are true?
1> Your offer of capital makes you a large shareholder in the company.
E.g. Warren Buffet's investment in Goldman Sachs, with the terms he could bargain for.

2> The capital markets enter a period of volatility that begins to approach uncertainty that venture capital investors face in their investment decisions.
E.g. The VIX crossing 85 in October'08, in the context of applying the Black Scholes model to investing decisions.

3> The capital markets face a liquidity crisis/ credit crunch.

Talking points:
1> Are these three conditions enough?
2> Does the "maturity" of the company mean anything beyond the ability to effect change within the organization, and the time required to effect this change?
3> Is looking at this question purely from the financial investing term sheet perspective inherently flawed?

Now that you have been anchored to the 3 follow up questions above, here are a couple more:
1. Is there a category of distressed company investing that is similar to venture capital investing?
2. Irrespective of how you categorize your investments or investing style, would you consider ending up looking at term sheets as an indicator of the end-of-the-road for that particular investment?

What do you think?