Is private equity really that bad?

Some years ago, we invited the very personable managing director of CHAMP Private Equity, David Jones (no relation to the retailer), to address our annual analyst conference. He graciously accepted our invitation and we all enjoyed his presentation, although I've had no contact with him since.

In the intervening years, we've perhaps taken some delight in spearing greedy private equity firms that acquired companies, tarted them up, and then flogged them back to the sharemarket at inflated prices. I did exactly that in my special report on the Myer float and certainly do not apologise for the criticism directed at the TPG consortium for that overpriced offer.

Some years ago, we invited the very personable managing director of CHAMP Private Equity, David Jones (no relation to the retailer), to address our annual analyst conference. He graciously accepted our invitation and we all enjoyed his presentation, although I've had no contact with him since.

In the intervening years, we've perhaps taken some delight in spearing greedy private equity firms that acquired companies, tarted them up, and then flogged them back to the sharemarket at inflated prices. I did exactly that in my special report on the Myer float and certainly do not apologise for the criticism directed at the TPG consortium for that overpriced offer.

Like all generalisations, however, it's important not to tar everyone with the same brush. It was interesting to read David Jones' comments on the private equity (PE) industry in the December edition of inFinance (only available to members of FINSIA unfortunately).

Two of his comments in particular struck me. The first was 'A commonly held myth is that PE gears businesses up too much and then strips back capital expenditure ... the reverse is actually true. We typically bring a large amount of capital to the business after we have bought it'.

This was indeed the case with Myer. The TPG consortium did invest a lot of capital, much more than originally forecast, to bring the business up to scratch. But my suspicion is that the about-face on capital spending occurred because the consortium made the mistake of starving Debenhams in the UK and didn't want a repeat in Australia. Presumably PE firms like CHAMP prefer to invest more capital because they believe it will result in a better eventual sale price, while others just want to extract every last cent early.

Jones' second comment relates to incentives: 'By bringing in PE capital, it can generate renewed energy and focus on the business by the management team, often creating a step-change in performance'. Again, I suspect this is true. Neglected businesses can produce low staff morale, so presumably incentives to perform and try new things can energise management and staff. This must be beneficial to many businesses, as it presumably has been with Myer.

So private equity firms are not inherently 'bad'. Like any investor, they take risks (admittedly with other peoples' money). CHAMP has had successful investments, but it has also had failures, including Australian Discount Retail (the former discount variety business of Miller's Retail), which fell into receivership in 2009. The price of strong returns is higher than average risk.

Banks don't need to lend private equity firms money, although of course they should require an adequate return on their money. Nor do investors or other companies need to buy the assets private equity sells. While I have little doubt the tactics of some private equity firms verge on the questionable, other participants – lenders as well as downstream buyers – must take responsibility for their investment decisions also.

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