NEW YORK – Private equity has become such a sweeping force in the capital markets that it is not only driving the public markets, but eventually will come to compete with them, according to a controversial assessment by Michael Klein, global co-head of investment banking at Salomon Smith Barney.
“Private equity today is a parallel capital market,” said Klein, who noted in a recent interview that the private equity universe has grown an average of 50% a year for two decades. “It’s a universe that is very large, all asset managed, broken down with massive geographic and industry diversity, and across all investment life cycles.”
While acknowledging the spectacular growth in the area – activity in both leveraged buyouts and venture capital for the first half of 2000 set records, according to Thomson Financial Securities Data and Venture Economics – some others familiar with the field think Klein’s assessment is a bit of a stretch.
“Year 2000 we now have a massive scale institutionalized private equity market; even in a catastrophe – a big setback in the markets – this business is not going away, it’s permanent,” conceded Mark Patterson, vice chairman and global head of Credit Suisse First Boston’s leveraged finance and LBO coverage. “But I wouldn’t go so far and say it would compare equally or roughly equally in scale to the public markets. That’s almost nutty.”
Klein, however, seems unfazed by his detractors, and points to an impressive array of statistics that he thinks bolster his arguments. For instance, it is estimated by several sources that private equity firms now control 10% of U.S. public markets. For the first half of 2000, some $70 billion in the full range of private equity – including buyouts, venture capital and international funds – has been raised, compared to $100 billion in primary and secondary offerings in the public market, according to Klein.
“The comparison is stunning; they’re running at that pace collectively,” Klein said, further pointing to the abundance of small and mid-cap under-performers in the public sector that have good reason to want to go private. “The opportunity [for going-private transactions] is unmistakable,” he said.
Nonetheless, to some, comparing the amount of private capital collected to that invested in initial public offerings is misleading. “While there’s been an exponential expansion of monies available under private equity, clearly it doesn’t reach the public equity markets, because it’s still only 10%,” said Harold Bogle, managing director and head of CSFB’s leveraged finance group. “The $70 billion is not the amount that will necessarily be invested in one year. Those monies are expected to be drawn down and invested over two to five years.”
The beast changes
While the public vs. private face-off in capital raising isn’t likely to happen anytime soon, the nature of the private equity beast has indeed changed – and become more expansive and pliable in the process.
Unregulated capital “is much more flexible in what it will do,” said Mark Stephanz, head of Banc of America’s financial sponsors group. “You see a lot more minority investments in public companies under various structures, with various terms.”
The simple early-stage venture capital model and the simple LBO model have expanded into “all kinds of things firms will do, including investing in big convertible preferreds in public companies and a lot of PIPE deals, added Kevin Albert, head of Merrill Lynch & Co.’s private equity group.
Today investing takes place during all stages of the corporate lifecycle, not only during the start-up period or buyout stage, but also throughout a company’s entire development, expansion, reengineering life. “You have such optionality,” said Klein, “that you can hold a company until you find a window that gives you the greatest value. Firms are much more comfortable holding public stakes than before.”
Indeed, many traditional private equity firms are doing early-stage investments like VC firms, whereas VC firms that used to hand things off in the second or third round of financing aren’t doing that anymore, and are acting more like private equity firms. “There’s much more variety today. It’s harder to say: This is a LBO firm; this is a purely venture firm; this is a growth capital firm,'” said CSFB’s Patterson.
The most versatile players are even adding asset management to their repertoire. Mutual fund manager Putnam has a stake in Thomas H. Lee Co., the private equity firm, as does T. Rowe Price in Silver Lake Partners. Indeed, private equity firms, which by definition have no liquidity, find influence by holding board seats and getting access to Wall Street research and trading distribution. “Look at David Rubenstein of Carlyle,” said Patterson. “He’s not just in the LBO space; he has mezzanine funds, CBO funds, venture funds, Asian funds, real estate. He’s in every kind of asset class.” Klein estimated that the combined assets under management of private equity approaches 30% of the total equity in mutual funds.
Becoming real in Europe
The explosive growth of private equity players, while not necessarily slowing down in volume, is starting to experience a rationalization process. “What’s now evolving is that private equity firms want to be global leaders like Kohlberg Kravis Roberts, Warburg Pincus, and Clayton Dubilier & Rice,” said David Webb, head of Merrill’s financial sponsors group. “Or have a very specific geographic or industry niche like Silver Lake Partners for tech, Heartland Industrial Partners for industrials; and in Europe, for example, Butler Capital in France.”
Among the leading U.S. sponsors abroad are Hicks, Muse, Tate & Furst, KKR, The Blackstone Group and Welsh Carson. Europe, in particular, is seeing more leveraged deals. “The buyout business has finally become a real business in Europe,” says Chad Leat, head of global loans for Citibank/Salomon Smith Barney, which financed Callahan Associates International LLC’s buyout of a cable network in Germany – the largest buyout ever done in Europe.
“In the U.S. you can pick your product – bank loans, commercial paper, junk bonds, mezzanine debt, private equity – but in Europe the markets are dramatically less developed. So the bank loan market has been the principal provider over the decade,” explained CSFB’s Patterson. The force now, however, is the local sterling and euro junk bond market, the fastest growth sector of the junk market worldwide. “That’s providing the ability to do more leveraged buyouts by eliminating a foreign exchange exposure,” he added. CSFB did such a private equity deal recently for themselves, and is now the proud owner of a large number of bingo parlors.
Meanwhile, new private equity funds continue to cascade in both size and number. Just last month, Goldman, Sachs & Co. completed a $5.25 billion private equity fund to invest in LBOs and young technology companies. And Donaldson, Lufkin & Jenrette announced plans to form a group to raise private equity capital for real estate investments.