Wednesday, July 26, 2006

The Private Equity Buyout Effect
Here Come The B.S.D.s

It is a significant deal, when Merrill Lynch paid one of their regular visits to HCA, the commercial American hospital company. Merrill Lynch had an audacious proposal: assembling a group of private investors to acquire the company for more than $US30 billion. The deal, including debt, is the largest leveraged buy-out ever, worth $US33 billion. Ignoring inflation, that eclipses the historic $US30.6 billion takeover of RJR Nabisco in 1989. The 89 episode was the subject material for the wildy successful book Barbarians At The Gate, easily one of my favourite books of all time. I guess the barbarians have returned again, only this time, the gates are more welcoming.

I have mentioned often that the funds raised by the private equity buyout firms over the last 12 months points to more bigger deals in order for the funds to perform. Private equity firms like Kohlberg Kravis Roberts, which came to fame in the RJR buyout, and others largely unknown outside Wall Street now possess more than $US2 trillion in buying power. In addition to KKR, the new brand names of finance are Bain Capital, Blackstone Group, Carlyle Group, and Texas Pacific Group. The companies they own include Hertz and Warner Music. The deal-making prowess of the big private equity firms means that they have become Wall Street's most important clients.

The buy-out spree is expected to run on. Some big public companies, fed up with scrutiny from investors and regulators, are now selling themselves to private equity firms. And private equity is increasingly able to take on bigger deals. Firms raised more than $US260 billion worldwide this year from big money managers like pension funds. Earlier this month Blackstone Group raised $US15.6 billion, creating the world's largest private equity fund. Private equity firms use the money they have raised and borrow more to buy businesses. The firms borrow against the value of the asset and its cash flow that they are acquiring, often allowing the firms to invest only a small sum of equity in a large transaction.

In the HCA deal the three private equity firms - Bain, KKR and Merrill Lynch's buy-out unit - and the Frist family are investing $US5.5 billion in cash. The rest of the $US33 billion price tag is being financed by debt, which the firms hope to pay down, like a mortgage payment, using HCA's income. Taking advantage of relatively cheap borrowing costs, private equity firms have gone on a worldwide shopping spree. Already this year private equity has bought well-known brands, worth more than $US347 billion, twice last year's pace. Private equity firms spent $US12.3 billion for Univision last month; $US22 billion for Kinder Morgan in May; as much as $US14 billion for General Motors' finance unit, GMAC, in April; and $US17.4 billion for Albertsons, the supermarket chain, in January.

The implications are manifold, but mostly good. We have currently listed US companies holding onto the largest cash balance in their books in history. We also have private equity with enormous booty to invest. The twain shall meet. There are sufficient big candidates to absorb the initial investments. It will have the effect of boosting valuation for similar companies in similar industries. It will create positive vibes for equity sentiment.

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