Dec 30, 2020
Private Equity Ran Amok in the 2010s
(Bloomberg Opinion) -- Twenty years ago, writing in Fortune magazine, I dubbed the 1990s “the Nasdaq Decade.” And why not? Practically from the moment the browser company Netscape went public, the tech stocks that dominated the Nasdaq stock exchange only went up. Cisco Systems Inc. rose 125,000% in the 1990s. Dell Technologies Inc. was up 72,000%. Shares of EToys quadrupled on their first day of trading in 1999. The Nasdaq itself rose 685%.
But a few months after the decade ended, the internet bubble burst, and by 2002 the Nasdaq had declined 78%. The tech highfliers that had soared in the 1990s either went bankrupt or their valuations crashed back to earth.
Financially speaking, the 2010s have been characterized by corporate mergers, aggressive activist investors, out-of-control CEO pay and “maximizing shareholder value.” But more than anything, it has been a decade awash in private equity deals. I therefore dub it the private equity decade. And I’ll admit that I’m rooting for private equity to get a comeuppance similar to the one that took place in tech after the Nasdaq decade.
Private equity deals have been part of the financial landscape for decades, of course. Who can forget KKR’s $25 billion leveraged buyout (as they were called then) of RJR Nabisco in the late 1980s — a deal memorialized in the classic book “Barbarians at the Gate?” Indeed, some of the biggest private equity deals on record — TXU Energy, First Data, Alltel, Hilton Worldwide — took place in the frothy years before the 2008 financial crisis.
What was different in the 2010s was less the size of the deals as their proliferation. In 2009, private equity firms completed 1,927 deals worth $142 billion, according to the financial data firm Pitchbook. By 2018, there were 5,180 private equity deals worth $727 billion.
Why so many deals? One reason is more firms are holding more capital than they know what to do with; Bain & Co. recently estimated that private equity firms have a staggering $2 trillion in “dry powder” that they need to deploy. But another reason is that there just aren’t as many big deals available as there used to be, so firms have had to move down the food chain to find companies willing to be bought out. Many, if not most, of the deals in the past few years have been for less than $500 million. I half expect the bodega down the street to be bought out.
What has also become clear this decade is the high-minded rationale the private equity industry once used to justify its deals has largely evaporated. You don’t hear much anymore about how taking a company private will remove short-term incentives, impose necessary restructuring, yadda, yadda, yadda.
The main thing private equity has done this decade is to pile debt onto companies — imposing repayment costs while pulling out fees and dividends that have no bearing on what the private equity firm has actually done. Famously, Toys “R” Us went bankrupt because it was buried in private equity debt. So did Gymboree, Sports Authority, Linens ’n Things, and many others. In 2017, when the Limited announced it was shutting down its 250 stores — and throwing its employees out of work — the private equity firm that owned it, Sun Capital Partners Inc., reported to investors that it had nearly doubled its money, thanks to the dividends and fees it had paid itself.
One private equity skeptic, Daniel Rasmussen, conducted a study to see the effect private equity firms had on the companies they bought. Using a database of 390 deals with more than $700 billion in enterprise value, he found that:
In 54 percent of the transactions we examined, revenue growth slowed. In 45 percent, margins contracted. And in 55 percent, capex spending as a percentage of sales declined. Most private equity firms are cutting long-term investments, not increasing them, resulting in slower growth, not faster growth.
Instead, he continued, there is a new paradigm for understanding the PE model:
As an industry, PE firms take control of businesses to increase debt and redirect spending from capital expenditures and other forms of investment toward paying down that debt. As a result, or in tandem, the growth of the business slows. That is a simple, structural change, not a grand shift in strategy or a change that really requires any expertise in management.
In other words, whatever larger purpose private equity might have once had, the 2010s exposed an industry that cared about lining its own pockets — often at the expense of the companies it bought. It has become dealmaking for its own sake.
It seems to me that there are two likely consequences for the devolution of private equity in this decade. The first is that when the business cycle finally turns, the consequences for the thousands of companies carrying private equity debt are likely to be severe. As increasing amounts of capital have chased deals this decade, purchase prices have increased drastically. Rasmussen reports that in 2013, private equity deals were done at an average of 8.9 times adjusted earnings. Today, that number has risen to 11 times adjusted earnings. That means the debt loads are becoming heavier.
The second consequence is political. If the Democrats take the Senate or the presidency — or both — the private equity model is going to be under sustained attack. Titans like Henry Kravis and Steve Schwarzman will be hauled before Congress and berated for the industry’s practices. Already, Elizabeth Warren has put forth a proposal to rein in private equity — she calls it the “Stop Wall Street Looting Act.” Among other things, it would give workers rights when a bankruptcy takes place and would put private equity firms “on the hook for the debts of companies they buy.”
One other thing: In this decade of growing income inequality, nothing symbolized the gap between the haves and the have-nots like private equity. When it can walk away enriched while companies it owns go bankrupt — is that really the way capitalism is supposed to work? Perhaps the 2020s will be the decade when it starts to work for everyone again.
To contact the author of this story: Joe Nocera at firstname.lastname@example.org
To contact the editor responsible for this story: Daniel Niemi at email@example.com
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Joe Nocera is a Bloomberg Opinion columnist covering business. He has written business columns for Esquire, GQ and the New York Times, and is the former editorial director of Fortune. His latest project is the Bloomberg-Wondery podcast "The Shrink Next Door."
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